Capital & Regional geared for recovery

In the slump, high gearing proved the undoing of property firm Capital & Regional. However, now that property values are increasing again, the company's high gearing could be a major advantage.

Capital & Regional's structure as a co-investing fund manager acts as a 'double magnifier' on its leveraged position. There is debt at the group level (69 per cent pro-forma gearing since the equity raise last summer), and the three UK retail and leisure property funds that C&R manages and co-invests in are also heavily debt backed. The Mall Fund, a portfolio of 21 regional shopping centres, is 80.5 per cent geared; The Junction Fund, which owns 12 out-of-town retail parks, is 75.4 per cent geared; finally the X-Leisure Fund, which owns leisure resorts including the X-Scape indoor ski centres, is 77.1 per cent geared.

The 2008 slump in property values coincided with various tenant insolvencies (including Woolworths and Land of Leather). So to stay inside banking covenants, all three funds have had to sell assets and raise equity. This means that collectively, they are the three worst-performing funds in the AREF UK index. Furthermore, C&R's own share price collapsed from 800p in 2007 to a low of 7p in 2009 as investors worried about the solvency of the company.

Such dire performance has already cost the scalp of long-running chief executive Martin Barber. His replacement, former ABN Amro chief Hugh Scott-Barrett, has been at the helm since March 2008, and pulled off a major refinancing and £69.2m equity raise in August. Backed by South African property company ParkDev, which is now C&R's largest shareholder controlling 25.4 per cent of the shares, it could be a powerful ally in the future when the time comes to launch new real estate funds.

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The summer fundraising aside, the current strength of the investment property market means the group has been able to execute asset sales well above valuation, further stabilising balance sheets. For instance, in November, The Mall Fund sold a shopping centre in Bexleyheath for £97.9m (that's £7.2m above the September valuation). The group has also sold its swanky head office, which overlooks Buckingham Palace, for £10.5m and will move into cheaper rented accommodation which will save an estimated £0.5m a year. Other major assets from its funds, including the Manchester Evening News Arena, Great Northern Warehouse and a leisure park in Hemel Hempstead, are effectively on the market.

The tenant profile has also proved more resilient than investors had feared. At the half-year stage in June, overall occupancy across the three funds was 93.6 per cent, and this figure rose to 94.2 per cent by November's trading statement. Insolvencies have slowed, and though the tenant market remains week, new lettings are in evidence (in the first six months of the year The Mall made 154 new lettings). Encouragingly, the average lease length to break across all three funds is relatively high at 12.7 years.

The most onerous financial event looming is a £1.25bn Mall Fund bond refinancing due in April 2012. With the securitised debt markets effectively closed, the fund’s current loan-to-value ratio of 80 per cent will need to be drastically reduced to enable a refinancing, which though not impossible, will be expensive.