Triple Point Social Housing REIT — Robust base and capital deployment options

While the H123 financial results were, as expected, significantly affected by the issues with My Space and Parasol, there was no read-across to the wider portfolio, which continues to perform as expected. In this report we provide an update to our detailed report published in April, with a particular focus on the continuing low valuation placed on the stock and SOHO's future capital allocation strategy.

Despite progress with resolving the My Space and Parasol issues (see below), strengthening demand for SSH accommodation, supportive evidence for asset values and the positive affirmation of the business model implied by the renewal of the company’s investment grade credit rating, we note that the current valuation of the shares remains at a material discount to peers and, we believe, discounts a significant risk to income. On a range of measures, the shares are trading at a c 50% discount to that implied by the recent agreed acquisition of close peer Civitas (page 7).

The successful sale of four diverse properties for £7.6m, just 3.6% below the 30 June 2023 book value, is supportive of both published valuations and NAV, and demonstrates continued investor demand for SSH properties. The properties were located across four local authorities, leased to Inclusion Housing and Chrysalis, with care provided by four separate care providers. The portfolio contained a mixture of adapted and new build properties as well as individual and shared homes.

With the board strongly focused on closing the discount to NAV, in consultation with shareholders it will determine whether to return a portion of the property sale proceeds by way of further share repurchases. Over the medium term, the company says that its aim is to supplement its existing portfolio of properties with forward funding projects and acquisitions, but that all deployment will be considered in the context of delivering shareholder value and the broader market conditions.

We estimate that while both repurchases and acquisitions would create value, the greater immediate return from repurchases should be quickly erased by rental growth on acquisitions (page 8). The strength of SSH demand and SOHO’s ability to grow in partnership with strong providers of SSH such as Golden Lane further reinforces the strategic merits of acquisitions.

SOHO has leases with a diverse range of 27 approved providers (APs),1 and the majority of these have performed steadily over the past year, successfully navigating the twin challenges of inflation and labour shortages well. However, as previously reported, two APs, Parasol (9.2% of rents) and My Space (7.7%) fell behind with their rental payments over the course of 2022 and continuing through H123. Post period end, in August, SOHO put in place a creditor agreement with Parasol, which sets a minimum level for monthly rent payments over a six-month period. At the end of the six-month agreement, full rent becomes due again. If this is not the case, SOHO retains the ability to move leases to a different RP and has held constructive discussions with potential alternative partners. The company says that it has built a constructive relationship with the leadership team, recently strengthened, and continues to support them as they move the organisation forward.

SOHO hopes to soon finalise a similar creditor agreement with My Space, required to help enable My Space to address its solvency position, and expects it to cover both the rent that will be due going forward and arrears. My Space has significantly strengthened its leadership, having recently recruited a new CEO and CFO. It is recruiting a COO, while at the same time, new trustees are in the process of being identified for the board, with the aim of enhancing My Space’s level of audit, financial and legal expertise. Among a number of options, My Space continues to consider a possible business combination or merger. Meanwhile, SOHO has identified alternative lessees to whom the properties leased to My Space can be moved if required. My Space continues to engage with the Regulator of Social Housing (RSH) in relation to the Enforcement Notice issued earlier this year, has undertaken a range of the actions prescribed and has provided an initial response to all points raised in the notice.

Following a period of consultation with stakeholders, including the RSH, in June SOHO began the roll-out of its new lease clause. The aim is to address some of the general risks raised by the RSH in relation to long leases by increasing the risk sharing between SOHO and its RPs and providing protection against factors that are beyond their control. This may be a change to government funding policy or local government commissioning where the income that RPs are able to generate from a property is reduced. In some such circumstances, and subject to a materiality threshold, the clause allows for the RP to agree a new rent level that reflects the revised circumstances. Should the new rent level not be acceptable to the company, it has the ability to re-assign or terminate the lease.

Additionally, the new clause provides for contractual rent increases to be linked to the lower of UK CPI (or RPI where applicable), or the maximum rent increase allowed under prevailing central housing policy to the extent that it applies to SSH. To date, leases have included annual upward-only rent increases linked to inflation only and it is hoped that the change will further address the points raised by the RSH. The new clause would not have had an impact on FY23 rent increases as SSH was not included in the social housing rent cap and, based on historical experience, we believe that it is unlikely to have any practical impact on medium-term rent growth.

The external portfolio valuers have indicated that there is unlikely to be any negative impact on SOHO’s portfolio and lenders have agreed to the inclusion of the clause in SOHO’s leases.

SOHO describes the level of RPs seeking funding partners for the delivery of their development pipelines as ‘exceptional’. It sees a partnership approach as critical to addressing the shortage of SSH and it is a primary driver of its new relationship with Golden Lane, one of the leading RPs in the SSH sector, with a regulatory compliance rating of G1 V2.2

SOHO is working on a pipeline of projects with Golden Lane and initially hopes to invest in conjunction with it, in what it describes as a competitively priced forward funding project to be constructed by a developer that it knows well and has worked with in the past. The project is for the development of 12 adapted flats for people with learning disabilities in Chorley and 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, and these are typically low risk, being pre-let with fixed construction costs. We would expect the yield on investment to be c 6% (portfolio EPRA net initial yield of 5.65%), well ahead of the 2.74% cost of debt, fixed for around 10 years, and Golden Lane is an excellent partner with which to grow.

During H123, growth in rental income substantially offset the impact of credit loss provisions, while costs and fixed rate finance charges were flat. Nonetheless, adjusted earnings of £8.9m was £1.5m or 14% lower versus H122 and £1.0m lower than H222 (£9.9m). The fall in EPRA earnings was moderated by lower amortisation of loan arrangement fees, excluded from adjusted earnings.3

The £3.2m credit provision in H123 included c £1.0m relating to prior year arrears. Excluding all credit provisioning, as a guide to underlying progress in the wider portfolio, adjusted earnings increased £1.2m versus H122 and £0.5m versus H222.

SOHO’s leases are all linked to inflation (92.4% CPI and 7.6% RPI) with only 4.9% containing caps, and subject to annual reviews. To assist APs in an inflationary environment while continuing to deliver attractive income growth for shareholders, SOHO decided to voluntarily limit rent increases to 7% for 2023, in line with the government’s cap on social housing rent increases from 1 April 2023, even though SSH was exempted from this. UK inflation remained elevated during H123 (the year-over-year increase in CPI was 8.0% at 30 June, having been as high as 10.4% in February), and annual reviews completed during H123, c 70% of the total, were in line with SOHO’s increase limit, and added 4.8% to annualised rent.

Investment management fees, linked to the level of NAV, were slightly lower than in H122 and administration expenses increased 6% with inflation. With interest costs fixed, finance expenses were unchanged.

Rental growth more than offset general market yield widening (the EPRA net initial yield increased to 5.65% compared with 5.46% at end-FY22), generating property revaluation gains of £5.9m and growth in NAV per share despite dividend distributions being only partly covered by underlying earnings. NAV per share increased 2.1% in the period to 111.3p (FY22: 109.1p) and including DPS paid the NAV total return was 4.6%.

SOHO has delivered positive accounting/NAV total returns3F4 each year since listing in August 2017 to the end of H123. Aggregate NAV total return over the period was 40.2% or an annual average of 5.9%, with dividends paid accounting for more than 70% of the total.

NAV return has also been positive on a quarterly basis with the exception of Q422 (-1.0%), when yield widening had a negative impact on property values, although these were significantly more robust than for the broad UK commercial property sector, benefiting from long, inflation indexed leases.

Until FY22, dividend cover (on an adjusted earnings basis5) had been steadily increasing as the company built scale. The dip in FY22 cover to 0.92x (FY21: 0.99x) primarily reflected the full-year impact of SOHO’s well-timed refinancing of borrowings at a fixed (but increased) cost in late 2021. As a result of the increase in credit losses, H123 cover was 0.81x on an adjusted basis but would have been c 0.9x excluding credit losses provision taken against the FY22 arrears. We forecast cover to increase in H223 as rent collection improves and provisions begin to fall, with unchanged 0.92x cover for the year. In the absence of further rent provisions, we forecast DPS to be well covered in FY24.

Despite SOHO delivering low volatility and consistently positive accounting returns, our FY23 DPS estimate of 5.46p represents a yield of c 10%, while the shares are trading at an almost 50% discount to H123 NAV.

Exhibit 6 shows a comparison of a selected group of companies that we would consider to be the closest peers to SOHO, investing in housing and healthcare properties. Given their long-lease income characteristics, share prices across the group have been negatively affected by rising bond yields in recent months, more so than the broader REIT sector. This is despite being driven by strong demographic and/or social trends with little or no correlation to the economy, vulnerable to the impact of higher interest rates on growth.

SOHO shares offer a noticeably higher yield than the average and trade at a significantly lower P/NAV ratio, despite its track record of positive financial and operation performance and delivery of material social benefit.

SOHO’s closest comparator, Civitas, no longer appears in the peer group comparison following its agreed acquisition by Hong Kong-based property developer CK Asset Holdings6 in June 20237 for 80p in cash. In recommending the offer, the board of Civitas commented that while it believed it undervalued the long-term prospects of the company, it recognised that Civitas, and its sector as a whole, was facing a number of challenges in sentiment, which the public markets were unlikely to overcome in the short to medium term. In this context, its decision was swayed by the immediate liquidity that the bid would provide to shareholders, with the opportunity to exit in full and in cash at a significant premium to the prevailing share price, in a time of macroeconomic uncertainty.

Taking the Civitas data as off 31 March 2023 (end-FY23), the bid represented a 27% discount to NAV, much narrower than the c 50% discount on which SOHO shares continue to trade. Including this with a range of portfolio metrics, we estimate the Civitas acquisition price to have been at least c 50% above the current SOHO rating, a strong indicator of value in the SOHO shares.

The average trailing yield of the peer group excluding SOHO is c 7.6%. Based on our FY24 forecasts we estimate that SOHO could withstand a c 20% reduction in forecast income while still generating sufficient earnings to pay fully covered DPS of c 4.5p, reflecting a similar 7.6% yield.

Over the medium term, SOHO aims to grow its portfolio further, with a focus on creating new capacity to meet the current lack of supply for SSH and the expected growth in demand. In the short term, increased capital costs, not fully reflected in asset yields, require a highly selective approach to investment. With the board focused on creating shareholder value, particularly on closing the material discount to NAV, during H123 it favoured share repurchases over acquisitions, completing a £5m buy-back programme (9.2m shares or 2.3% of the total outstanding) at an accretive average discount to prevailing NAV of 52.8%. Meanwhile, the completed sale of the four-property portfolio that was announced 1 September provides supportive evidence of the robustness of asset valuations and published NAV.

H123 share repurchases enhanced NAV per share by 1.27p, 1.1% of the end-FY22 value, and improved dividend cover. Attractive as this was, there are other relevant considerations with respect to further share repurchases. These will typically have a negative impact on share trading liquidity, more likely to hinder a re-rating of the shares. Where funded by asset sales, there is a loss of scale and upwards pressure on cost ratios. The effective near-term withdrawal from the market at a time of strong (‘unprecedented’) demand for funding from RP partners is both negative for the creation of social value and risks impeding the development of attractive opportunities with those partners over the medium term. The forward funding agreement with Golden Lane is a case in point.

SOHO’s end-H123 cash position was £23.8m, subsequently increased by the £7.9m (before costs) portfolio sale. An amount of this is available for deployment, but not all, after allowance for items including prudent liquidity reserves, declared dividend payments and planned capex including environmental efficiency upgrades. For illustrative purposes we have compared the immediate financial impact of £10m invested in additional income earning portfolio assets (at a yield of 6.0%) with a similar value of share repurchases at the current share price, on an annualised basis. Both are immediately accretive to earnings although the uplift from share re-purchase (4.8%) is twice that from portfolio investment. However, that gap should quickly narrow with indexed rental growth on the assets. Similarly, while repurchases are accretive to NAV per share (2.3% in the illustration), assuming an unchanged property valuation yield, future rental growth should be reflected in higher property values and NAV. Meanwhile, share repurchases modestly lift gearing (shown below as net loan to value or LTV).

We have lowered our forecast for adjusted earnings by c 7% for FY23 and c 1% for FY24. Across the period, lower forecast rental income is partly offset by lower expenses. The non-core asset sale reduces annual rental income by c £0.4m, while the Golden Lane forward funding, if agreed by both parties, is unlikely to contribute meaningfully to rental income until FY25. We have assumed that the annual rate of CPI for September will be 6.0%, feeding through to rental growth after 7% in FY23. The reported 12-month change in CPI to July 2023 was 6.9%.

Rent collection was stronger than we expected in H123 but progress with My Space and Parasol has been a little slower than we had assumed, and this is reflected in a lower H223 collection rate and higher provisioning than we previously forecast. We nonetheless expect increased rent collections against the properties currently leased to My Space (c £3.0m of rent pa) and to Parasol (c £3.6m of rent pa) in H223 before normalising from the beginning of 2024. Provisions have been taken against current arrears but, despite this being included in the creditor agreements, conservatively we do not forecast recovery of back rents.

Our forecasts imply c 94% rent collection for H223 and 91% for the year, with full collection in FY24. Our FY24 rental income forecast recognises the possibility of the rents on the My Space assets being renegotiated, particularly if reassigned (this is specifically excluded in respect of the Parasol assets) and builds in a c 20% or £0.6m reduction.

We expect a strong recovery in earnings in FY24 as indexed rent growth continues and rent provisioning falls away, sufficient to increase DPS on a fully covered basis. We forecast 4.4% growth in FY24 DPS to 5.7p, 1.1x covered by adjusted earnings.

Our NAV forecasts include some further property yield widening, by c 20bp to c 5.85% (previously 5.65%).