The Investment Column: Best may be over in dash by companies to convert to Reits

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The Independent Online

Ten of Britain's biggest listed commercial property companies officially converted into Real Estate Investment Trusts or Reits yesterday. Among those who switched to the tax-efficient format were British Land, Land Securities, Slough Estates, Liberty International, Great Portland Estates and Hammerson.

The transformation means that these companies no longer have to pay corporation tax on returns produced by their portfolios. The move will also unlock the value of many portfolios because Reits pay no capital gains tax on profits made from the sale of assets. Of course, those converting into a trust face a cost, but it is one well worth splashing out on. Property groups have to pay a one-off charge equivalent to 2 per cent of the value of their portfolio to the Treasury. In British Land's case, this is around £300m, equal one year's corporation tax bill.

From here on in British Land is free to expand its property interests with little hindrance from the tax authorities as long as it distributes 90 per cent of its income to investors as dividends. Its shares, like the rest, remain listed on the London market as before.

But, valuations across the sector, which soared ahead of yesterday's conversion, are now beginning to look rather stretched. Whereas historically companies traded at a discount to their net asset value, they now trade at a premium. Pension funds, who like to have large chunks of the money they manage invested in commercial property, have invested heavily in the sector over the past few months. These investors now find that owning shares in a Reit is almost the same as controlling their own portfolio of commercial properties directly.

On average the like of British Land, Land Securities, Hammerson and Slough Estates traded at a 10 per cent premium to net asset value. This means that a building worth £10m on its own is worth £11m to the stock market in the form of a Reit. Although these valuations may seem excessive, they are conservative when compared to those abroad. European listed Reits trade at a premium of between 25 and 30 per cent to their assets and Australian Reits at up to 40 per cent.

Clearly commercial property is in fashion in a big way at the moment. The investment community is in love with assets that can deliver predictable cashflows and property fits the profile perfectly. The introduction of Reits has greatly fuelled this ardour. The UK property sector has tripled in value over the past four years while the FTSE All Share has gained a relatively meagre 70 per cent.

Most City analysts expect property stocks to continue to outperform in the short term predicting that a "wall of money" from pension funds will drive valuations still higher. In fact, recent research suggests that European pension funds have allocated too little cash to the sector compared to other parts of the stock market and are likely to rush to address the balance in 2007.

However, valuations cannot carry on rising at their current rate for much longer. If they do there is a danger they will enter bubble territory, the way internet stocks did seven years ago. With the sector offering a dividend yield of less than 3 per cent even after raising its payout to take account of the new Reit regulations, now is the time for readers to take the bulk of their chips off the table.

Worthington Nicholls

Our view: Hold

Share price: 120.5p (+2p)

Worthington Nicholls is the UK's leading installer and maintainer of air conditioning units for hotels and shops. Yesterday, the Manchester-based company unveiled its first European contract which will see it install new and replacement air conditioning systems for Grand City Hotels & Resorts at the Park Hotel, Amsterdam. The deal should be complete by the summer and is worth €350,000, but, more importantly, it could lead to significantly larger contracts with the hotel group in the future.

This would be a major coup for Worthington Nicholls as the Berlin based company manages hotels under a series of brands in The Netherlands and Germany - it has approximately 3,000 rooms in Germany alone. It also reduces the air conditioning group's reliance on the UK market.

Worthington Nicholls listed on AIM last summer, raising £20m at 50p. Since then its shares have soared. They closed at 120.5p yesterday giving it a market capitalisation of £86m. The group was founded 33 years ago by Peter Worthington who sold his house and moved in with his parents in order to start the business. It remains very much a family affair. Mr Worthington, at the age of 70 is its non-executive chairman, his son, Mark, is chief executive and the family retain a 42 per cent stake in the business.

The group's largest client is InterContinental Hotels, owner of the Crowne Plaza and Holiday Inn chains, for which Mr Worthington previously worked as an engineering director in Africa. Other clients include Hilton and Boots, the UK retailer.

Having made a pre-tax profit of £300,000 last year, stockbroker Corporate Synergy, which floated Worthington Nicholls, expects it to make £3.6m in the current year and £6.2m next year. Of course, should it get a further order from Grand City Hotels & Resorts or any other hotels group on the continent, these forecasts will end up looking far too conservative.

Given the growth, Worthington Nicholls stock is well worth holding on to despite its strong rise since floatation.

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