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British (fantasy) Land for shares

August 18, 2009

Shares in British Land, a big UK property company, have rocketed by almost two thirds from their March lows. After Tuesday’s results, they stand at a one-third premium to net asset value (NAV) of 361 pence per share. Fuelled by takeover speculation, the shares seem to be orbiting far above bricks-and-mortar reality.

Further fuel has been provided by the cost of much of Land’s outstanding debt. This is so far below the market rate as to be worth a further 119 pence a share on the company’s estimate. Together with associates, Land has 4.8 billion pounds of net debt fixed at 5.3 percent with an average maturity of 12.6 years.

Bank of America Merrill Lynch believes that fresh buyers, chasing yield, are being attracted into the sector. At 482 pence, Land shares yield 5.4 percent on the likely payout for 2010. This optimism ignores some home truths.

First, property yields have traditionally fluctuated around 8 percent, reflecting their capital intensity and the risky nature of property development. Moreover, previous returns have been juiced up by lashings of debt. While debt markets have re-opened, credit is still scarce and expensive. Analysts report that banks are much happier to lend on new projects, with lower base valuations, harder terms and lower loan-to-value ratios,than to refinance existing debt.

More fundamentally, unlike consumer cyclicals, property companies do not bounce back rapidly at the first sign of green shoots. British Land reports pressure on rents, which is likely to continue as unemployment rises. It is a renters’ market, with 36 month rent-free periods for new tenants and even on renewals not uncommon.

British Land bulls point to its prime portfolio and long leases, offering prospects to a big buyer that would otherwise take years to assemble. The Daily Telegraph has linked the magic words “takeover” and “Mittal” and “Abu Dhabi” with the company.

Others report that Blackstone, the American private equity group, could buy 50 percent of British Land’s City Broadgate development. (Whether the bottom of the cycle is a good time to sell is another question).

Yet, with its valuation flying around a third above the underlying NAV, all these fantasies, and more, are already reflected in the share price.

(Margaret Doyle owns shares in British Land)

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