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Research: Real Estate
Picton Property Income’s (PCTN’s) Q323 report shows asset management and leasing activity continuing to grow rental income. This provided a partial offset to strong market-wide pressure on property valuations in response to higher interest rates, while moderate gearing mitigated the impact on NAV. Although the NAV total return was a negative 11.7%, PCTN appears to have delivered strong outperformance relative to MSCI indices and those immediate peers that have so far reported.
Picton Property Income |
Growing income and portfolio outperformance |
Q323 NAV update |
Real estate |
3 February 2023 |
Share price performance
Business description
Next events
Analyst
Picton Property Income is a research client of Edison Investment Research Limited |
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Picton Property Income’s (PCTN’s) Q323 report shows asset management and leasing activity continuing to grow rental income. This provided a partial offset to strong market-wide pressure on property valuations in response to higher interest rates, while moderate gearing mitigated the impact on NAV. Although the NAV total return was a negative 11.7%, PCTN appears to have delivered strong outperformance relative to MSCI indices and those immediate peers that have so far reported.
Year end |
Net property |
EPRA |
EPRA |
DPS |
NAV** per share (p) |
P/NAV |
Yield |
03/21 |
33.5 |
20.1 |
3.7 |
2.93 |
97 |
0.85 |
3.6% |
03/22 |
35.4 |
21.2 |
3.9 |
3.45 |
120 |
0.68 |
4.2% |
03/23e |
36.5 |
21.1 |
3.9 |
3.50 |
98 |
0.84 |
4.3% |
03/24e |
38.0 |
21.6 |
4.0 |
3.60 |
98 |
0.84 |
4.4% |
Note: *EPRA earnings exclude revaluation gains/losses and other exceptional items. **NAV measure is net tangible assets (NTA), currently the same as IFRS NAV.
Successful focus on the things that it can control
PCTN’s Q323 unaudited EPRA net income covered DPS 1.12x (H123: 1.12x) and the annualised rate of quarterly DPS remains 3.5p. Despite high uncertainty for occupiers as well as investors, leasing events across all sectors continued at average levels above ERV/previous passing rent. Capital values across all sectors of the market declined sharply although ERV growth in industrials and, to a lesser extent, offices continued. MSCI data indicate a market-wide decline in capital values of more than 15% in the quarter, the largest since the index began in 1987. The like-for-like capital value decline for PCTN’s portfolio was 9.0% and we expect it will have outperformed its benchmark MSCI UK Quarterly Property Index return, when available, as it has been over one, three, five and 10 years since inception. The market-wide decline in capital values slowed in December and may indicate a period of greater stability. We have nonetheless increased our estimate of PCTN’s H223 property valuation decline to 12% (previously 10%) and NAV by 3p to 98p.
Continuing opportunities to grow income
Picton is total return driven with an income focus. It has successfully generated attractive returns through proactive management of its portfolio, investing in assets where it believes there are opportunities to enhance income and value. Most of its recurring income is distributed via fully covered DPS while retaining surplus cash for reinvestment back into the portfolio. Asset management opportunities remain strong. In H123 the existing portfolio contained significant organic growth potential with a c £13m gap between passing rent and ERV. More than £5m related to the letting of mostly refurbished assets, much of which remains, providing an opportunity to grow further income and support property values.
Valuation: DPS fully covered with surplus for growth
The current annualised rate of DPS (3.5p) represents a prospective yield of 4.3% and we forecast further growth, fully covered in FY24. The FY23e P/NAV is c 0.84x, which is below the five-year average of c 0.94x and a peak of c 1.1x.
Further details
Looking back 10 full years, beginning with FY13, Picton has generated a total return of 137% or an average 8.4% pa, including the negative 12.9% in the first nine months of FY23, of which 11.7% was in Q323.
Exhibit 1: Q123–Q323 total returns
Q123 |
Q223 |
Q323 |
First 9 months of FY23 |
|
30-Jun-22 |
30-Sep-22 |
31-Dec-22 |
||
Opening NAV per share (p) |
120.4 |
122.9 |
116.7 |
120 |
Closing NAV per share (p) |
122.9 |
116.7 |
102.2 |
102 |
DPS paid (p) |
0.875 |
0.875 |
0.875 |
2.625 |
Dividend return |
0.7% |
0.7% |
0.7% |
2.2% |
Capital return |
2.1% |
-5.0% |
-12.4% |
-15.1% |
NAV total return |
2.8% |
-4.3% |
-11.7% |
-12.9% |
Source: Picton Property Income data, Edison Investment Research
The commercial property market is cyclical and in common with the sector, Picton’s across-the-cycle income return has been much more stable than the capital return.
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Exhibit 2: Income provides a relatively more stable bedrock to performance |
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Source: Picton Property Income, Edison Investment Research |
The impact of property revaluation movements on Q323 NAV is clearly seen in Exhibit 3. Earnings excluding valuation movements (‘EPRA earnings’) was £5.3m, consistent with our unchanged full- year expectations, covering DPS 1.12x, as in H123.
Exhibit 3: Reconciliation of Q322 NAV movement
£m |
Movement |
Pence per share |
|
NAV at 30 September 2022 |
636.4 |
116.7 |
|
Movement in property values |
(79.8) |
-12.5% |
(14.6) |
Net income after tax for the period |
5.3 |
0.9% |
1.0 |
Dividends paid |
(4.8) |
-0.8% |
(0.9) |
Other |
0.2 |
0.0 |
|
NAV at 31 December 2022 |
557.3 |
-12.4% |
102.2 |
Source: Picton Property Income
After a long period of rising property values, interrupted for a time during the pandemic, due to a combination of rising bond yields, economic and political uncertainty, a sharp reduction in investment demand for UK commercial property, and eager selling by some open-ended funds and even insurance companies this has spectacularly reversed. This is despite many areas of the market continuing to report robust levels of occupier demand and increasing rents.
While property values are declining across the market, there has thus far been a tendency for sectors where yields had been lowest to adjust more than average. This is true of the industrial sector positive occupational demand and increasing rents. The MSCI Monthly UK Index,0F2 All-Property return was a negative 14.5% in the three months to 31 December, including a negative capital return of 15.6%, compared with a negative total return of 4.5% in the previous quarter. In the most recent quarter, industrials capital values were c 20% lower and office and retail assets were each down 12–13%.
The data are collected from funds that report their portfolio returns monthly. The MSCI Quarterly UK Index, comprises the funds that report portfolio returns monthly and those that report quarterly. Compared with the quarterly index, the number of funds that contribute to the monthly index is therefore smaller and includes a higher proportion of open-ended funds.
October and November each showed monthly declines of 6–7% but this slowed in December to c 4%. The December slowdown was despite expectations that some investors, including within the UK open-ended funds and pension funds sectors, would be relatively less price sensitive as they sought to raise year-end liquidity.
Money market interest rate expectations remain volatile and have recently moved in the direction of higher for longer, but 10-year government gilt yields have been moving in a lower, tighter range (c 3.2% currently) since peaking at c 4.5% last autumn. Alongside this, MSCI data indicate that the occupier market remains robust with estimated rental values continuing to increase (1.6% in the industrial sector in the three months to December and 0.3% in offices). It may be that yield widening is in the process of stabilising.
The Picton portfolio continues to outperform
PCTN’s Q323 like-for-like capital value decline of 9% (12% including Q223) compares favourably with the MSCI monthly index although directionally it shows similar sector trends, and with those close peers that have so far published quarterly reports.1F3 We are disinclined to read too much into shorter-term divergences as leasing events (including tenant retention) and other asset management initiatives can have a significant impact. In all cases, valuations are produced externally by independent valuers.
AEW REIT (AEW), Balanced Commercial Property Trust (BCPT), Schroder Real Estate Investment Trust (SREI) and CT Property Trust (CCPT).
Exhibit 4: Portfolio weighting, like-for-like valuation change, and yield movement
Portfolio allocation |
Like-for-like valuation change |
Average equivalent yield movement |
|
Industrial weighting |
57.4% |
-9.9% |
+75 bps |
o/w South-East |
41.7% |
||
o/w Rest of UK |
15.7% |
||
Office weighting |
32.1% |
-7.4% |
+55 bps |
o/w London City & West End |
7.2% |
||
o/w inner & outer London |
5.7% |
||
o/w South-East |
9.1% |
||
o/w Rest of UK |
10.1% |
||
Retail & Leisure weighting |
10.5% |
-8.3% |
+65 bps |
o/w Retail Warehouse |
6.6% |
||
o/w High Street Rest of UK |
2.3% |
||
o/w Leisure |
1.6% |
||
Total |
100.0% |
-9.0% |
Source: Picton Property Income
Within the PCTN portfolio, the industrial sector saw the greatest widening in yields, although the impact was mitigated by rising rental values and further capture of ERV growth. This included three rent reviews at a combined rent of £0.9m, 39% ahead of the previous passing rent and 5% ahead of the September ERV. Office sector assets, where PCTN’s void reduction opportunity is greatest, benefitted from new lets and lease regearing, all above ERV and/or passing rent. In the retail and leisure sector, retail warehouse assets saw larger downward valuation movements than higher yielding high street assets.
The MSCI Quarterly UK Index, against which PCTN measures its property performance, is not yet available for the three months to 31 December. However, based on monthly index data we are reasonably confident that PCTN will have outperformed, as it has done over one, three, five and 10 years since inception. Exhibits 5 and 6 show the data to 30 September 2022.
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Exhibit 5: Total property return versus index* |
Exhibit 6: Property income return versus index* |
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Source: Picton Property Income, MSCI. Note: Data to 30 September 2022. *Annualised percentage returns. |
Source: Picton Property Income, MSCI. Note: Data to 30 September 2022. *Annualised percentage returns. |
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Exhibit 5: Total property return versus index* |
|
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Source: Picton Property Income, MSCI. Note: Data to 30 September 2022. *Annualised percentage returns. |
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Exhibit 6: Property income return versus index* |
|
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Source: Picton Property Income, MSCI. Note: Data to 30 September 2022. *Annualised percentage returns. |
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Exhibit 7: Financial summary |
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Source: Picton Property Income historical data, Edison Investment Research forecasts |
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Research: Investment Companies
Martin Currie Global Portfolio Trust (MNP) has been managed by Zehrid Osmani since 1 October 2018. Despite a tough period of absolute and relative underperformance in 2022 as growth stocks have been out of favour with investors, the manager continues to adhere to his long-term strategy of focusing on high-quality companies with sustainable growth potential. He believes that valuation discipline is a very important element of the investment process, even more so in periods of rising interest rates. Osmani only invests when he has high conviction in a company’s positive long-term prospects; this is evidenced by no new holdings (or complete disposals) in the five months from May to September 2022, although portfolio activity has subsequently picked up.
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