At the time I thought that the stage was set fair for gains in commercial property valuations in the regions, reflecting improved tenant demand and a hardening of rents as both consumer spending and the domestic economy recovered. An uptick in investor interest in the higher yielding property on offer outside London was likely to play its part too. In the event, this scenario has played out perfectly with Town Centre Securities announcing a 10 per cent like-for-like increase in the value of its investment portfolio in the financial year to end June 2014. That mainly reflected a hefty 80 basis point contraction in the initial yield on the portfolio to 6.4 per cent. Factor in rental income and the total return from the portfolio was 17.6 per cent, inline with the IPD benchmark index.
The company’s strongest performer was its flagship asset, The Merrion Centre in Leeds, which increased in value by 23 per cent in the period and accounts for a third of the company’s portfolio by value. Buoyed by strong interest from retailers and benefiting from store upgrades this resulted in passing rent at The Merrion Centre rising by £1m a year to account for a third of the £3m increase in the company’s open market rental income to £22.7m.
Yield contraction and occupier demand to drive capital growth
It is also clear to me that the lack of new supply of property coming onto the market generally, combined with improving occupier demand, is likely to drive rents higher and underpin a further contraction in investment yields. Analysts are thinking the same way too. For instance, John Cahill at brokerage Oriel Securities has hiked his June 2015 year-end net asset value (NAV) estimate up from 305p to 341p a share after Town Centre Securities increased NAV by 15 per cent to 308p in the year to June 2014. This forecast is based on the assumption of 5 per cent capital growth in the year ahead which may yet prove too conservative. That’s because Mr Cahill’s model has factored in 2 per cent income growth across the book, but only a 20 basis point contraction in the initial yield used by surveyors to value the portfolio. But even on this basis, the shares are still being priced on a thumping 26 per cent discount to prospective book value.
In my opinion, that share price discount is wholly unwarranted given that the investment risk of further valuation uplifts is skewed to the upside. Indeed, Town Centre Securities’ financial leverage – its loan-to-value average of 49 per cent is above the sector average of 35 per cent – means that the company’s net asset value is more sensitive to changes in the value of the portfolio, something that is beneficial in a rising property market. But there are no financial concerns to fret about as two thirds of the company’s net borrowings of £160m are being funded by long-dated debenture stock maturing in 2031. The average cost of debt is 4.2 per cent, down from 4.6 per cent in fiscal 2013, which means interest payments are covered twice over by underlying operating profit.
High yield, high growth
It’s also worth flagging up that the company pays a healthy dividend and one that was maintained at 10.44p a share, including a final dividend of 7.34p (ex-dividend date of 3 December). As a real-estate investment trust (REIT), Town Centre Securities’ board is obliged to pay-out 90 per cent of the profits of the property rental business, after certain deductions, to shareholders as a Property Income Distribution. Last year’s underlying EPS of 14.4p (excluding valuation gains worth 37.3p a share) easily covered that payout and means the current yield of 4 per cent is rock solid. The REIT average is nearer 3.4 per cent, so there is value here too.
In my view, the combination of a regional property portfolio generating rising income and with high occupancy rates, and one likely to benefit from rising investor demand, creates a very favourable investment case. Trading on a bid offer spread of 250p to 252p, I continue to rate Town Centre Securities’ shares a buy and maintain a target price of 290p.
Please note that I last updated the investment case four months ago (‘Playing the regional property game’, 29 May 2014).
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