Grainger to shine through house price gloom

As one of Britain's biggest homeowners, Grainger may not seem an obvious choice for bargain-hunting investors. After all, residential property trades on notoriously low yields in the UK, with prices having been bid up to excessive levels by successive generations of owner occupiers looking for a tax-free store for their equity.

Yet Grainger's portfolio is currently available at 38 per cent below its book value (adjusted for various non-cash items). Shares in the company quintupled in the so-called 'dash to trash' that followed the crash, but, since October 2009, have fallen back 36 per cent as investors have fretted about house prices. On a long-term view, that presents a rare opportunity to lock in bricks and mortar at a reasonable price.

It's true that Grainger acts in part as a geared play on house prices, which have been sinking across most of the UK since last summer. There are some signs that prices are bottoming out again, but data from Halifax still showed declines. Also, in the longer run, the prospect of interest rate rises does not bode well.

However, national statistics are misleading in such a localised market as property, and Grainger's track record of relative resilience is more telling. Over the year to September 2010, it reported a 4.8 per cent increase in values, compared with an average rise of 2.9 per cent for the Nationwide and Halifax indices. Moreover, last month, it announced that the increase in the first half of 2010-11 (to be announced on 19 May) would be around 2 per cent. That reflects the company's bias towards London and the south-east, which account for two-thirds of the portfolio by value.

In any case, Grainger is not simply a play on house prices. It also makes cash profits by collecting rents. At £40.8m, these were up 6 per cent last year, and the outlook is bright too - at least in the south-east. Young professionals are renting for increasingly long periods before buying: the latest English Housing Survey found 15.6 per cent of households in the private rented sector in 2009-10, up from 14.2 per cent the previous year. That growth in demand, coupled with a shutdown in construction over the past three years, is pushing up rents.

Grainger is also unusual in aggressively churning its portfolio to generate trading profits. It buys houses cheaply (including through equity release) and sells them when they become vacant. This business earned it even more than rents last year - £58m, up 23 per cent on the year. The company also paved the way for future profits by spending £56m on 308 more properties.

The acquisition drive has continued this year. In February, Grainger bought a portfolio of 317 homes around Bristol and Portsmouth that are leased to the Ministry of Defence for a net yield of 8.4 per cent. That deal won't necessarily generate much capital growth under the terms of a complex long-term lease, but the income will boost the company's cash flow - hence, possibly, the dividend.

Grainger also signed an innovative and potentially lucrative deal with Lloyds Banking Group this month. It will manage any homes that Lloyds puts into a special fund, receiving fees based on rent and disposals.