London property values still have a dose of the shakes in the wake of the referendum, and real estate companies with big development arms have been regarded as particularly vulnerable. However, Armageddon is yet to make an appearance and it now looks as though there are selective bargains to be had among the stronger performers tarred with the Brexit brush.
- Very low gearing
- Strong development pipeline largely pre-let
- Rental income expected to accelerate
- Adept at picking up assets in improving locations
- Modest dividend
- Vulnerable to downturn in property market
This brings real estate investment trust Derwent London (DLN) to mind, specialising as it does in commercial real estate predominantly in central London. Derwent has a strong record for spotting the right properties in the right areas and, crucially, at the right time. The business model also embraces recycling capital by selling mature assets and reinvesting the proceeds. And despite the savage markdown in valuations meted out by valuers, in the first nine months of 2016 it made £135m of disposals in line with December 2015 book values.
Focusing on mid-market rental levels, Derwent has had little trouble in attracting new tenants, and by the end of the third quarter of 2016 it had exceeded lettings for the whole of 2015, letting out 495,300 sq ft and generating £28.3m of annualised rental income. What's more, average rents have been secured at 6.9 per cent ahead of December 2015 estimated rental value (ERV). And even after the referendum shock, when over two fifths of the letting was done, the average was still 2.8 per cent above June 2016 ERV. The vacancy rate is just 3.3 per cent.
And while there is a considerable amount of uncertainty over whether the financial sector will move away from London, Derwent derives less than 3 per cent of rental income from the industry. Three major refurbishments have been completed this year. Phase 1 at the White Chapel building is already 75 per cent let, while 20 Farringdon Road is 81 per cent let. The Network building is 28 per cent let, and together these projects have an estimated rental value of £15.2m a year.
| DERWENT LONDON (DLN) | ||||
|---|---|---|---|---|
| ORD PRICE: | 2,609p | MARKET VALUE: | £2.91bn | |
| TOUCH: | 2,608-2,610p | 12-MONTH HIGH: | 3,507p | LOW: 2,230p |
| FORWARD DIVIDEND YIELD: | 2% | FORWARD PE RATIO: | 31 | |
| DISCOUNT TO FORWARD NAV: | 34% | NET DEBT: | 27% | |
| INVESTMENT PROPERTIES: | £5bn | |||
| Year to 31 Dec | Net asset value (p)* | Net operating income (£m)* | Earnings per share (p)* | Dividend per share (p) |
|---|---|---|---|---|
| 2013 | 2,342 | 124 | 53.9 | 36.5 |
| 2014 | 3,062 | 136 | 57.1 | 39.7 |
| 2015 | 3,962 | 149 | 71.3 | 43.4 |
| 2016* | 4,014 | 148 | 77.8 | 47.7 |
| 2017* | 3,967 | 163 | 84.2 | 52.5 |
| % change | -1 | +10 | +8 | +10 |
Normal market size: 750 Matched bargain trading Beta: 0.57 *Liberum forecasts, adjusted NAV, NOI and EPS numbers | ||||
After the referendum, Derwent stood out as the company with the largest development arm, with £408m of capital expenditure needed to complete its schemes. Of the 1.02m sq ft currently being worked on, delivery is expected sometime on the four major projects between the first quarter of this year and the first half of 2019. Crucially, a significant part of this has been effectively de-risked, with 400,000 sq ft due for completion by the second half of 2017 already two-thirds pre-let.
Looking further ahead, Derwent assessed the options on the Brunel building and pushing ahead with completion expected in 2019. Together with 80 Charlotte Street, where demolition work is in hand and planned completion also in 2019, around £326m of capital expenditure will be required, with an estimated rental value when fully let of £41.2m a year.
Funding all this work means that net debt has edged up to just over £1bn, with undrawn facilities and cash of £269m at the end of September. However, given the size of the property portfolio, this means that the June loan-to-value ratio is low at 19.3 per cent.
Inevitably, there will continue to be a measure of uncertainty until Brexit proceeds beyond the embryonic stage, and Derwent does expect to see the 2.9 per cent decline in the IPD Central London Office index reflected in its full-year valuation. Rising bond yields could also negatively affect valuers' assumptions, should they persist.
However, while many investors are wary of real estate at the moment, it might be unwise to tar the whole sector with the same brush or be too pessimistic. Derwent London releases its full-year figures for the year to December 2016 on 28 February, and judging by the upbeat tone of the third-quarter trading update, which revealed that new lettings are at an all-time high, full-year numbers could bring some reassurance.
