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Research: Real Estate
Regional REIT
Written by
Regional REIT |
Regional property doing well |
Trading update |
Real estate |
22 November 2016 |
Share price performance
Business description
Next events
Analysts
Regional REIT is a research client of Edison Investment Research Limited |
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Regional property markets have performed well in Q3 and market growth expectations favour the provinces over London, with initial concerns following the EU referendum abating slightly. This supports Regional REIT’s (RGL’s) fundamental investment case. RGL invests mainly in office and light industrial assets outside the M25 and pursues an active asset management strategy to improve income and capital value growth, which has increased occupancy and headline rents in Q3. The diverse portfolio supports a 7.2% prospective dividend yield, among the highest of UK REITS, while the shares trade at an undemanding 0.97x EPRA NAV.
Year |
Net rental |
EPRA EPS* |
EPRA NAV/ |
DPS |
P/EPRA NAV |
Yield |
12/15** |
4.6 |
0.9 |
107.8 |
1.0 |
0.99 |
0.9 |
12/16e |
37.2 |
7.7 |
110.6 |
7.7 |
0.97 |
7.2 |
12/17e |
41.4 |
8.9 |
113.7 |
8.9 |
0.94 |
8.3 |
12/18e |
43.3 |
9.5 |
115.4 |
9.5 |
0.93 |
8.9 |
Note: *EPRA EPS is adjusted to include exceptional expenses related to listing and includes estimated performance fees. **56-day trading period only.
Executing strategy
Rebalancing the portfolio towards office and industrial property in England and Wales continued in Q3 and the active asset management strategy has also been evident: in 9M16 RGL secured 90 new leases (43 in Q3) and re-geared 33 (with an average increase of 1.2% in headline rent), relating to 7.8% of units in the portfolio, and occupancy rose to 83.4% (30 June: 81.8%). Gross capex investment in the existing portfolio totalled £9.2m, or £6.1m after recoveries and dilapidations. Although a property portfolio near Glasgow was acquired in the quarter, Scotland now represents 27.3% of properties by value, down from 35.4% at IPO, and office and industrial sites have risen to 91.7% from 83.7% of the portfolio.
Market drivers remain strong
The RICS Q316 UK Commercial Property Market Survey indicates a rebound in sentiment after expectations dipped immediately after the EU referendum. Of the UK’s regions, London, where RGL is not active, was noted as the only exception to increases in occupier demand and decreases in availability. The industrial sector in particular is expected to see rental and capital value growth, with little expectation that Brexit will negatively affect most businesses. Structural drivers of regional commercial property markets are also positive, and supported by government infrastructure plans and the devolution of powers to major regional cities. With the regions performing better than London, investment flows may adjust, narrowing the gap between prime and secondary regional yields, which would benefit RGL.
Valuation: Discount
RGL’s fully covered prospective yield of c 7.2% leads the UK REIT sector, while the discount to EPRA NAV of 3% is close to the sector average, having narrowed since our update note of 4 October. This trend may continue if regional commercial property markets outperform London as expected.
November 2016 trading update
The trading update was in line with both management expectations and our estimates and only a slight change has been made to the latter to account for higher than expected capex. A dividend of 1.75p per share will be paid on 22 December in respect of the quarter from 1 July to 30 September 2016, the same as the two previous quarterly dividends. It is the board’s intention that the fourth quarterly dividend will at least ensure compliance with the REIT distribution rule. We summarise the main points from the update below:
■
Q3 lease renewal progress has been good: 75% (by value) of leases up for renewal in the period have been either re-geared (renegotiated), re-tenanted or the old tenants are currently holding over in the properties while negotiations continue.
■
The 33 re-geared leases (40% of the total number up for renewal) have seen an average uplift of 1.2% above the headline rent. In addition, 43 new leases were signed in the quarter, and will generate c £4.5m of rental income pa when fully occupied, including 10-year leases with E.ON and Equitable Life for c £495k and £426k a year respectively. The new E.ON lease demonstrates how active asset management of individual units can add value across a property: the lease relates to 47,000sq ft at Newstead Court for £10.50/sq ft, immediately adjacent to an area twice as large, which was previously let at £9.50/sq ft, giving proven rent reversion of 10.5%.
■
Occupancy across the portfolio was 83.4% by area at 30 September vs 81.8% at 30 June. The Wing Portfolio is now 85.2% occupied vs 78.2% at acquisition in March 2016 and the Rainbow Portfolio, also acquired in March, has seen occupancy rise to 78.2% from 77.2%.
■
On 20 September, RGL completed the acquisition of the Wallace Portfolio from the asset manager, London & Scottish Investments, for £5.5m in cash at a net initial yield of 12%. The portfolio comprises six office units at a business park east of Glasgow. The company also disposed of three small non-core properties for £0.34m in the quarter. The group portfolio now consists of 964 units at 126 properties valued at c £505m and with a contracted rent roll of c £44.9m pa.
Valuation
We continue to forecast on the assumption that the portfolio will reach 85% occupancy by the end of 2016, rising to 88% at the end of 2017 and reaching the long-term structural occupancy level of 90% in 2018. The contracted rent roll has increased in line with our modelling assumptions and we maintain our 28.1% ratio of expenses to gross rental income, which we expect to decline over 2017. The only change to our estimates has been to increase our assumed capex for 2016 to £8m from £4m to account for the £6.1m net expenditure in the first nine months. RGL trades below EPRA NAV and has a prospective dividend yield of 7.2%, amongst the highest in the UK REIT sector (Exhibit 1). Including the dividend, RGL aims to provide 10-15% total returns pa to shareholders on the IPO price of 100p. The capital appreciation portion of the return target would be supported by continued strengthening of the regional property market, and the rental increases and new leases secured in Q3 point to a positive outlook.
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Exhibit 1: UK REITs by prospective dividend yield |
|
|
Source: Bloomberg, data as at 22 November 2016 |
Exhibit 2: Financial summary
Year end 31 December |
2015 |
2016e |
2017e |
2018e |
||
PROFIT & LOSS |
£'000s |
IFRS |
IFRS |
IFRS |
IFRS |
|
Gross rental income |
5,361 |
41,509 |
45,466 |
47,574 |
||
Non-recoverable property costs |
(754) |
(4,291) |
(4,092) |
(4,282) |
||
Revenue |
|
|
4,608 |
37,218 |
41,374 |
43,292 |
Administrative expenses |
(1,353) |
(7,380) |
(7,963) |
(8,212) |
||
EBITDA |
|
|
3,255 |
29,839 |
33,411 |
35,081 |
Gain on disposal of investment properties |
87 |
(75) |
0 |
0 |
||
Change in fair value of investment properties |
23,784 |
3,623 |
7,504 |
5,152 |
||
Operating profit before financing costs |
|
|
27,126 |
33,387 |
40,914 |
40,233 |
Performance fees |
0 |
(95) |
(974) |
(828) |
||
Exceptional items |
(5,296) |
0 |
0 |
0 |
||
Finance income |
177 |
97 |
68 |
25 |
||
Finance expense |
(997) |
(8,757) |
(9,161) |
(9,161) |
||
Net movement in the fair value of derivative financial investments |
115 |
(2,024) |
0 |
0 |
||
Profit Before Tax |
|
|
21,124 |
22,608 |
30,847 |
30,268 |
Tax |
0 |
0 |
0 |
0 |
||
Profit After Tax (FRS 3) |
|
|
21,124 |
22,608 |
30,847 |
30,268 |
Adjusted for the following: |
||||||
Performance fees |
0 |
95 |
974 |
828 |
||
Exceptional items |
5,296 |
0 |
0 |
0 |
||
Net gain/(loss) on revaluation |
(23,784) |
(3,623) |
(7,504) |
(5,152) |
||
Net movement in the fair value of derivative financial investments |
(180) |
1,904 |
0 |
0 |
||
Gain on disposal of investment properties |
(87) |
75 |
0 |
0 |
||
Profit before Tax (norm) |
|
|
2,370 |
21,059 |
24,317 |
25,944 |
Period end number of shares (m) |
274.2 |
274.2 |
274.2 |
274.2 |
||
Average Number of Shares Outstanding (m) |
274.2 |
274.2 |
274.2 |
274.2 |
||
Fully diluted average number of shares outstanding (m) |
274.2 |
274.2 |
274.2 |
274.2 |
||
EPS - fully diluted (p) |
|
|
7.7 |
8.2 |
11.2 |
11.0 |
EPS - normalised (p) |
|
|
0.9 |
7.7 |
8.9 |
9.5 |
Dividend per share (p) |
|
|
1.0 |
7.7 |
8.9 |
9.5 |
Dividend cover |
N/A |
100% |
100% |
100% |
||
BALANCE SHEET |
||||||
Fixed Assets |
|
|
407,492 |
516,918 |
532,421 |
545,573 |
Investment properties |
403,703 |
514,132 |
529,635 |
542,788 |
||
Goodwill |
2,786 |
2,786 |
2,786 |
2,786 |
||
Non-current receivables |
1,004 |
0 |
0 |
0 |
||
Current Assets |
|
|
35,803 |
27,284 |
22,351 |
15,497 |
Trade and other receivables |
11,848 |
13,816 |
13,195 |
14,527 |
||
Cash and equivalents |
23,954 |
13,468 |
9,157 |
970 |
||
Current Liabilities |
|
|
(21,485) |
(28,622) |
(30,693) |
(32,362) |
Trade and other payables |
(12,576) |
(15,354) |
(16,917) |
(18,169) |
||
Deferred income |
(5,906) |
(9,588) |
(10,097) |
(10,514) |
||
Taxation |
(2,387) |
(1,239) |
(1,239) |
(1,239) |
||
Bank and loan borrowings - current |
(200) |
0 |
0 |
0 |
||
Derivative financial instruments |
(416) |
(2,440) |
(2,440) |
(2,440) |
||
Long Term Liabilities |
|
|
(126,469) |
(214,771) |
(214,771) |
(214,771) |
Borrowings |
(126,469) |
(214,771) |
(214,771) |
(214,771) |
||
Net Assets |
|
|
295,341 |
300,809 |
309,308 |
313,937 |
Derivative interest rate swaps |
416 |
2,440 |
2,440 |
2,440 |
||
EPRA net assets |
|
|
295,757 |
303,249 |
311,748 |
316,377 |
IFRS NAV per share (p) |
107.7 |
109.7 |
112.8 |
114.5 |
||
EPRA NAV per share (p) |
107.8 |
110.6 |
113.7 |
115.4 |
||
LTV |
25.4% |
39.2% |
38.8% |
39.4% |
||
CASH FLOW |
||||||
Operating Cash Flow |
|
|
(2,232) |
28,800 |
35,130 |
34,589 |
Net Interest & other financing charges |
(411) |
(9,244) |
(9,093) |
(9,136) |
||
Tax |
0 |
0 |
0 |
0 |
||
Purchase of investment properties |
(4,191) |
(139,251) |
0 |
0 |
||
Sale of investment properties |
5,348 |
40,369 |
0 |
0 |
||
Capex |
(8,000) |
(8,000) |
(8,000) |
|||
Acquisition of subsidiaries, net of cash acquired |
26,659 |
0 |
0 |
0 |
||
Net proceeds from issue of shares |
0 |
0 |
0 |
0 |
||
Equity dividends paid |
0 |
(12,340) |
(22,349) |
(25,639) |
||
Other (including debt assumed on acquisition) |
0 |
1,077 |
0 |
0 |
||
Net Cash Flow |
25,172 |
(98,588) |
(4,312) |
(8,187) |
||
Opening net (debt)/cash |
|
|
(127,886) |
(102,714) |
(201,303) |
(205,614) |
Closing net (debt)/cash |
|
|
(102,714) |
(201,303) |
(205,614) |
(213,801) |
Source: Company accounts, Edison Investment Research
|
|