Admittedly, I am not talking about prime real estate located in the capital's plusher neighbourhoods, but mainly workshops and studios on industrial estates, former factories and office blocks close to major transport hubs. But to me this property looks undervalued as do the shares of the company, Workspace, which owns it. I am not alone in thinking this way as chairman Tony Hales has just splashed out over £100,000 buying shares in his company at 21.25p. A glance at Workspace's first-quarter trading update at the end of July explains why he has been heavily buying with the company reporting some pretty positive trading trends.
For instance, like-for-like occupancy rates on 88 of Workspace's properties rose 0.9 per cent to 84.9 per cent in the three months to end-June, but not at the expense of rentals, with the cash rent stable at around £11.76 per sq ft. And having lifted occupancy levels on these properties - book value of £536m - up from 82.7 per cent in September 2009, the aim is to raise this further to 90 per cent which would give a boost to the cash rent roll of £39.5m and narrow the gap with the ERV of £48.8m.
The company is also adding value by refurbishing another seven properties - market value of £134m - which now have a current cash rent roll of £10.1m, up from £9m in December, helped by an improvement in occupancy rates from 73 per to 76.1 per cent. These properties have an ERV of £12.1m, but at current rental levels are producing a healthy income yield of 7.7 per cent.
Moreover, the decision to buy back 18 properties at 11 locations, providing a total of 1.1m sq ft of space from a joint venture with HBOS, is looking increasingly smart. The deal was funded through a £68m debt facility from Bank of Scotland - maturing at the end of 2014 at a margin of 1.25 per cent above Libor - and cash payment of £15m, raised through a placing of shares at 19p at the end of last year. Given that Workspace had previously completely written down the value of its 50 per cent stake in the Glebe joint venture, by taking full ownership of £93.7m-worth of properties this immediately gave a boost to its net asset value (NAV). In effect, the portfolio was being acquired at an initial capital cost of only £75 per sq ft.
And there is significant scope to add value on several of these Glebe properties. For example, the site at Grand Union Centre, close to Ladbroke Grove in West London, has outline planning permission for 145 apartments and 110,000 sq ft of new commercial space, while in South London the two-acre Wandsworth Business village has planning approval for a major mixed-use scheme of 200 flats and 80,000 sq ft of space. The company has also made a planning application for 550 flats and 100,000 sq ft of new commercial space at the 3.5-acre Bow Enterprise site, located two stops on the Dockland Light Railway from the 2012 Olympic Village and only fours stops away from Canary Wharf.
Clearly, realising the upside from these developments will take time, but in the meantime Workspace receives a cash rent roll of £6.1m which comfortably covers the interest payments on the £68m debt facility. And although the benefit of future disposal proceeds (up to £170m) will be shared equally between Workspace and the lenders once the debt has been repaid and Workspace has recouped its £15m investment, Workspace will receive a 70 per cent share of all disposal proceeds between £170m and £200m and 100 per cent of any proceeds above £200m.
The management team, led by chief executive Harry Platt who retains over 4m shares in the company, can take its time to realise this value as Workspace has no funding worries, having refinanced a £200m five-year debt facility with Nationwide, Santander and BayernLB in July at a margin of 2.25 per cent above Libor. It also has another £150m facility with RBS which is not due for repayment for another two years. This means the company has £383m of debt in total secured on £725m-worth of properties to give a modest loan-to-value ratio of 53 per cent and untapped facilities of £31m. Shareholders can be patient, too, as the 0.75p-a-share annual dividend equates to a healthy 3.5 per cent yield.
Despite the obvious potential to generate significant capital upside for shareholders, Workspace's shares trade at 22.5p (on a tight 0.25p bid-offer spread), which is not only well below March 2010 NAV of 27p, but is over 20 per cent below brokers' 29p-a-share March 2011 estimate. That seems anomalous considering the company has a clear strategy to unlock value in its properties and is well funded to do so.
Interestingly, the shares have traded in a very tight range between 19p to 22p for the past six months and today's move above 22p has signalled a clear chart break-out targeting the April high of 25.5p and offering 12 per cent potential upside to narrow the share price discount to NAV to a more realistic 12 per cent. My near-term price target is 25.5p a share by the year-end and I rate the shares a short-term trading buy at 22.5p, placing a tight stop-loss of 18p on the trade.
