Triple Point Social Housing REIT — Improving rent collection and fully covered DPS

All rents are linked to either the CPI (92%) or RPI (8%) with an increasing overlay from SOHO’s new risk-sharing lease clause (for details see our March 2024 update). The clause has now been included in two-thirds of leases and SOHO hopes it will be fully rolled out before year-end. The clause sets rent uplifts at the lower of the relevant inflation index and the prevailing government policy towards social housing rent increases. Positively, the new government is indicating that it expects social housing rents to increase annually by CPI plus 1% for the next 10 years. This would indicate that SOHO rents will continue to track inflation while its tenant operators will be protected against inflationary cost pressures.

For the current year, two-thirds of SOHO’s rent reviews are linked to the September 2023 level of CPI (as is common practice in social housing) while others reflect the level of inflation prevailing at the time of review. During H124, reviews were completed on 66% of SOHO’s leases, resulting in an average uplift of 6.1% on previous rents. Of the remaining leases set to be reviewed in H224, around half are also linked to September 2023 CPI.

H124 rent collection increased to 93.3% compared with 88.1% in H123 and 90.2% for FY23 as a whole. Rent arrears across the portfolio represent the assets that continue to be leased to My Space (8.1% of rent roll) and the assets that were leased to Parasol (9.6% of rent roll) until being transferred to Westmoreland in August 2024. SOHO says that there are no material arrears elsewhere within the portfolio and this is supported by new disclosure on its top 10 tenants, excluding My Space and Parasol. SOHO has 27 tenants total and the other 15 represent a combined c 12% of rent roll.

The issues surrounding My Space and Parasol are covered in our March note. A creditor agreement that was put in place with Parasol in July 2023 (and later extended) was a first step in improving rent collection. The minimum monthly rent payments set under the agreement have been met in full, although the balance of rent specified in the lease agreement (we estimate c 40%) was deferred and recognised as a lease incentive. As a longer-term solution, in August 2024, the Parasol leases were transferred to Westmoreland. As a result, SOHO expects to increase rent collection from the properties to between 75% and 85% of the full amount of the existing leases’ rent during an initial stabilisation period (expected to last approximately 12 months), and thereafter up to at least 90%.

SOHO has been seeking a creditor agreement with My Space for some time and negotiations continue. We estimate that SOHO currently receives less than half of the rent due under the lease terms. However, following the successful transfer of leases away from Parasol, SOHO is engaging with My Space on how best to transfer some or all of its leases to an alternative provider, which should see a substantial increase in the rents collected.

In June 2024, SOHO announced that it had agreed heads of terms in relation to a portfolio sale with an aggregate value in excess of £20m, expecting the sale to complete in September. Progress has been made, and the 13 properties that comprise the portfolio have been transferred on the balance sheet to held for sale with a value of £21.8m. Completion is now expected in November, allowing more time for the purchaser’s debt funder to complete its work. SOHO says the composition of the portfolio being sold is representative of its wider portfolio and contains a range of both new build and adapted properties as well as self-contained and shared homes. The EPC2 ratings of the properties range from B to D.

The proceeds will support further share repurchases (shares with a value of £5m were repurchased in 2023) while also maintaining a suitable level of leverage. The board says that further portfolio sales will be considered.

Growth opportunities compete for capital

In June 2024, work commenced on the previously disclosed forward funding of a development of 12 adapted flats for people with learning disabilities in Chorley and which will be leased to Golden Lane.

Forward funding projects bring new, specially adapted supply to the sector and SOHO has completed 33 forward funding projects since launch, although the last was completed in March 2021. These are typically low risk, being pre-let with fixed construction costs. We would expect the initial yield on investment to be broadly in line with the portfolio average (ie 6%), well ahead of the 2.74% cost of debt, fixed for around 10 years. Subsequent rent indexation would generate an increasing return on cost. Strategically, Golden Lane is an excellent partner with which to grow.

In July 2023, SOHO launched the pilot phase of its ‘eco-retrofit’ project, which will see SOHO investing to upgrade the energy efficiency of certain of its properties and preserving their long-term value. All socially rented properties are required to have an EPC rating of C or above by 2030 and 71% of SOHO’s properties already meet this hurdle, compared with the 43% social housing sector average.

Of the 11 properties included in the pilot, which is not scheduled to complete until later in the year, eight now have an EPC rating of C or above and work continues on the other three. SOHO expects the project to come in under budget, in part because of the availability of grant funding. SOHO has not yet completed surveys of the larger group of properties in its portfolio that will be the subject of the post-pilot phase of the retrofit programme, but it currently estimates that, once grant funding is accounted for and assuming that it continues to be available, the cost should be between £2.5m and £5.0m.

Our adjusted earnings growth forecasts for FY24 and FY25 are reduced by 3% and 1%, respectively. For FY24 this is driven by higher credit loss impairment due to slower progress with Parasol and My Space than we had assumed. In FY25 it results from the portfolio disposal expected to complete in late 2024. We have assumed £20m of share repurchases, at the current share price, utilising the disposal proceeds, but spread evenly across FY25. On an annualised basis the asset sale and share repurchase is accretive to earnings and NTA, but because of the assumed lag in deploying the proceeds, the effect will not have a full impact until FY26.

The key drivers of performance over the forecast period are rent growth and rent collection. With inflation moderating, we expect like-for-like rent growth in FY24 to be c 5%. For FY25 we assume a 2% increase across the portfolio. We assume that rent collection for the leases recently transferred to Westmoreland increases in line with SOHO’s expectations. For the My Space leases we have assumed a full contribution from the beginning of FY25, but with a one-off step-down in rents of 15%. On this basis we forecast no recurrence of credit loss allowance in FY25.

We have previously noted that with rent collection and dividend cover rebuilding, and as issues with problem tenants move closer to a resolution, we expect investors to give greater focus to the underlying investment case and continuing low valuation of the shares. In particular, we would highlight:

In the table below we lead with EPRA earnings and show a reconciliation to the company’s adjusted ‘cash’ earnings, an approximate guide to the cash generated to support dividends, and then the statutory IFRS results. In summary we highlight:

Since listing in 2017, SOHO has built a track record of consistent, low-volatility accounting returns.

The accounting total return has not been matched by the share price and SOHO shares trade with a prospective FY24 yield of more than 8% and a discount to EPRA NTA of more than 40%.

SOHO’s share price has increased markedly from a 2023 low of c 42p, and over the past year it has strongly outperformed the selected group of peers listed below, a group of companies investing in some form of social housing or healthcare properties. Three-year and five-year performance is now broadly in line with peers. It should be noted, however, that the group has underperformed the wider property sector and the broad UK market more so. Compared with the peer group, SOHO’s valuation discount has narrowed but has not fully closed. Despite holding its dividend flat for the current financial year, its shares have retained a yield premium to peers and trade at a significantly higher discount to EPRA NTA.