I had good reason, too, because real estate is one of the major beneficiaries of the money printing programmes and ultra monetary policies being pursued by the world's major central banks. Financial repression in a negative real interest rate environment may be seriously bad news for savers whose bank deposits have been earning pitiful rates of return for the past five years, but it's rather good news for asset-backed investments generating solid yields. That's because there is a huge incentive for investors to move up the risk scale to replace lost income on safe gilts and AAA-backed bank deposits with alternative investments earning greater rates of return. In my opinion, this reallocation of assets has yet to fully run its course even though the US Federal Reserve is now tapering its third quantitative easing programme under new central bank chairman Janet Yellen.
Indeed, with both the Fed Funds rate and Bank of England base rate set to be anchored to record lows for some time yet, and short-term government bond yields on both sides of the Atlantic still at historically incredibly low levels, there is every incentive for income hungry investors to seek out real estate investments as an alternative income source. There are prospects of capital growth, too, albeit there is higher risk to your capital.
Hot property
Bearing this in mind I have been casting my eye over all of my real estate plays, all bar a few are massively in profit. However, I have yet to bank profits on any of them as I still feel there is more upside to come. And one that needs updating is FTSE 250 listed Daejan Holdings (DJAN: 4,999p).
To recap, I first advised buying the shares at 3,300p in mid-February 2013 ('Buy the breakout', 14 Feb 2013) when I noted the investment potential, since then the company's share price has jumped 50 per cent. For good measure, we have also banked a final dividend of 54p a share and a raised interim payout of 35p a share. It's a rock solid income stream, too, since the company can easily afford to pay out the £12.8m in annual dividends declared to shareholders out of its bumper rent roll of £112m. A dividend yield of around 1.8 per cent may be modest, but the payout has been growing at a steady pace, rising from 55p to 79p a share in the past decade alone.
Moreover, even though the shares have re-rated sharply since I initiated coverage, there is still value on offer as they are priced almost 25 per cent below the last reported book value of 6,449p a share at the end of September 2013. That share price discount is pretty harsh considering Daejan has been growing its asset base at a strong pace. In fact, net asset value per share rose from 5,678p in September 2012 to 6,044p by March 2013, before jumping by another 400p a share in the following six months. There are sound reasons to expect these valuation uplifts to continue to come through too.
Valuation uplifts underpin re-rating
The main reason for the ongoing rerating in Daejan’s share price is down to the fact that 80 per cent of the company's UK portfolio is located in the prosperous areas of London and southeast England. These investments were last valued at £1.1bn and are split between: offices (over a fifth of the UK portfolio); retail (around a quarter of the portfolio); and residential assets, worth £464m at the March financial year-end, accounting for more than 40 per cent of the book.
If exposure to the buoyant London residential and office market wasn't attractive enough, Daejan also owns a US portfolio that was last valued at just over £300m, of which 85 per cent is residential property. These assets consist of a New York portfolio valued at £160m, another in Boston worth £35m, and Florida properties which were last valued at £62m.
So, with property markets in London, New York and Boston continuing to attract strong investor demand, this has been feeding through to some pretty decent valuation uplifts on Daejan's properties. For instance, in the six months to end-September 2013, the portfolio enjoyed a £47.7m valuation uplift, or almost 300p a share, four times greater than in the previous year. A buoyant London residential market and improvements in yields and rentals in commercial property were key drivers as were gains from both the Boston portfolio and Daejan's prime New York properties.
Furthermore, it's only realistic to expect even more valuation gains at the full-year stage when Daejan reports its results in a few months time and not just from the company's London residential property portfolio. For instance, Daejan's prime commercial assets include the redevelopment of the Grade II-listed Africa House in the Aldwich, London. The property offers 118,000 sq ft of prime London West End space and completed at the end of last year. It will be interesting to see how much of the building has been let when the company next reports since property in the area commands prime rents.
Conservative balance sheet
It's worth pointing out that Daejan runs a very conservative balance sheet which is no bad thing. During the boom times in the last property bull market in the noughties, many large players overgeared their balance sheets and used debt to produce significant net asset value gains for shareholders when property values were rising. However, they were punished when valuations started to decline due to the gearing effect going into reverse.
There is no such risk of Daejan falling into that trap because at the September half year-end, the company had net debt of £208m secured against properties worth £1.45bn, equating to a very modest loan-to-value ratio of 14 per cent. Or put it another way, net borrowings now only represent less than 20 per cent of shareholders funds, which have risen by £300m to £1.05bn in the past four years on the back of valuation gains, development profits and retained earnings.
Furthermore, as I noted earlier, a growing rental stream - rental income has risen from £96m to £111m in the past four financial years - means that an annual rent roll of £112m covers the interest charge on net debt of £208m almost 10 times over.
Unwarranted share price discount
True, part of the hefty 25 per cent share price discount to book value is structural and that is not going to change anytime soon. To understand why you have to wind the clock back to 1939, when Osias Freshwater arrived in the UK, via Danzig, on the last ship to leave the port before the outbreak of the Second World War on a business visa with the intention of procuring visas for his family.
As Poland was invaded, his wife and three children subsequently fled from Danzig to Lvov, but sadly perished in the holocaust. Settling in London's East End in 1947, Mr Freshwater married Nechama Stempel the widowed daughter of Rabbi Bobov who together with her two children had evaded the Nazis to survive the war. Ten years later, Mr Freshwater reversed his property interests into a shell company, Daejan, to create a London quoted property vehicle which by the 1960s and 1970s was regarded as the London's largest private landlord. The two sons of Osias and Nechama Freshwater are both directors of the present day Daejan Holdings.
The connection doesn't end there because the family continues to have a dominant and majority shareholding in Daejan. In fact, by my reckoning the Freshwater family control well over 70 per cent of the share capital through direct interests, beneficial holdings and shares held in trust. As a result this reduces liquidity in the shares and explains part of the share price discount to book value.
Furthermore, and as noted when I initiated coverage 11 months ago, it really doesn't help matters that the company's board has a disinclination to talk to the press. The results statements are brief to say the least and though the annual report and accounts are far more informative, the lack of publicly available information is holding back the rating. That said, these factors do not justify valuing the shares at a 25 per cent discount to book value. A far more reasonable discount would be closer to 15 per cent, in my view. It's worth noting that although liquidity is below the average for a FTSE 250 company, the shares are easily tradable and the bid-offer spread is tight enough despite the large family holding reducing the free float.
Positive technical set-up
The strong fundamentals driving the re-rating aside, from a charting perspective the set-up is equally promising. A move through this month's high of 5,050p would be very positive and opens up the distinct possibility of a return to the March 2007 high around 5,835p. It would also signal a break-out on the point & figure chart (50 point) and on the swing chart too. On both counts it would be one worth following.
Interestingly, the reading on the 14-day relative strength index (RSI) is currently below 60 so this technical indicator is not overbought, thus offering the potential for a share price break-out, if it happens as seems likely, to be the real deal. Moreover, Daejan's share price is not over extended above its short-term 20-day moving average (4,876p) nor its 50-day average (around 4,700p).
In the circumstances, and in advance of full-year results scheduled to be released in early July, I am upgrading my target price to 5,800p, just below that key price level dating back to March 2007. Even then the shares would still only be trading on a 10 per cent discount to historic book value. Factor in retained earnings and possible valuation gains when the portfolio is revalued at the end of next month by surveyors Colliers CRE, and it would be no surprise to see a book value per share above 6800p.
Currently priced in the market on a bid-offer spread of 4,982p to 4,999p, and offering 16 per cent potential upside to my new target price, Daejan's shares rate a decent trading buy ahead of results in July. Buy.
