The UK property market could be about to crack. Here's how to trade the sector, analyst says

Published Mon, Oct 3 20227:23 PM EDTUpdated Thu, Oct 6 20223:00 AM EDT

The U.K.'s property market has been thrown into turmoil after political turmoil saw borrowing costs in the country soar. Earlier this month, expansive tax cuts announced by U.K. Finance Minister Kwasi Kwarteng sent yields on U.K. government bonds to their highest levels in over a decade. This saw British property stocks become less attractive to investors, who turned to government bonds as a higher-yielding — and safer — bets. As a result, investment research group Stifel Europe made "significant" downgrades across the sector. Here are the five stocks that saw the biggest cuts to their price targets by Stifel, along with their ratings: In a Sept. 30 report titled "In Liz we're Trussed," the analysts said interest rates, driven by government policy, were the key driver for their outlook on the property sector. "The gamble to generate growth via lower taxes has sent shock waves through the financial markets, such that the 10-year gilt yield is up over 100bps in two weeks, and 230bps in two months," they said. The report noted that the stock prices of property companies had yet to factor in the impact of rising interest rates, due to a lag between property valuations and the disclosure of these valuations. In the meantime, Stifel believes that corporate bond yields, which are priced in real-time, are good indicators of future pressures on property assets. One of the sector's leading companies, SEGRO, has seen the interest rate on its bonds rise to 6.4% from 1.2% just over a year ago. Hammerson, the owner of multiple shopping malls, has similarly seen its bond yields touch 10.7% from 2.6% last year. Shaftesbury The West End property investment company saw the biggest cut in price target in percentage terms from Stifel Europe. The analysts said that while the company might benefit from weaker sterling , it won't be immune to rising interest rates. Shares in the company have already fallen by 42% this year and are now trading at 3.5% below Stifel's price target. British Land Stifel said its previous positive outlook for the FTSE 100 company had reversed due to the significantly deteriorating macroeconomic conditions prompting a rating downgrade. The analysts expect the London office space property sector, where British Land has significant investments, to lose value this year, as well as 2023. Stifel's note to clients said British Land was unlikely to be upgraded in the short-term until there's more clarity on the change in property values. As a result, shares in the company have fallen by 35% this year. Great Portland Estates Despite suffering a 65% cut in its price target, the FTSE 250 stock still has a buy rating from Stifel. Shares in the company are expected to rise by 10% by the end of the year, according to Stifel. The research note said that while Great Portland Estates will also face headwinds from rising interest rates, its "conservatively financed" balance sheet will allow it to emerge stronger than its peers. The company reported a loan-to-value of just 24% in its most recent filing, which Stifel said will give it plenty of room to expand when property asset prices are declining. "The shares will likely be volatile in the short term, but at the current valuation, the shares represent a deep value opportunity for investors willing to endure a bumpy ride, in our opinion," they said. 'Radical change in political leadership' John Cahill, led analyst of the Stifel note, welcomed the U.K. government's U-turn on its plans to cut the top tax rate, but said he still saw their large spending plans as inappropriate in the current environment. "This may not be our last downgrade unless there is a radical change in political leadership in the U.K. and a U-turn in fiscal policy," he said in the note. "It is not impossible to imagine the Prime Minister fires the Chancellor in an effort to save her position and electoral suicide for the Conservative party." Correction: This article has been updated to reflect that Kwasi's tax cuts sent yields on U.K. government bonds higher.