Grainger looks set to takeover Aim-traded equity release specialist Sovereign Reversions, tabling a 185p-a-share offer earlier this month, valuing the company at £31m. Considering that the company owns and manages residential properties worth £550m, this looks to be a shrewd deal. However, Grainger will have to play the long game to get its hands on the property profits.
Under home reversion plans, elderly homeowners sell all or part of their homes in return for a lump sum payment, and have the right to remain in the house until they die. Grainger has quietly built up a 31 per cent market share of the UK's home reversions market through its Bridgewater Equity Release subsidiary.
Although sales of these kinds of products have been regulated by the Financial Services Authority since 2007, it's fair to say that equity release has a terrible reputation. Since its introduction in the 1980s, elderly home owners have been easy prey for unscrupulous operators offering derisory sums for high-value homes, leaving pensioners with little or no inheritance to pass on. However, the ageing population and looming pensions crisis mean that equity release could end up funding the retirement dreams of the baby-boomer generation.
No longer seen as a product of last resort for the poor, the biggest issue for the market is now not one of perception, but availability. By its very nature, funding equity release products is cash intensive, as money advanced at the start of the loan will not recouped for a long period. Funding issues have caused major building societies to step back from the market, and established operators including Retirement Plus and Stonehaven have temporarily withdrawn products.
And financial issues caused a boardroom spat at Sovereign Reversions at the end of last year. Following an attempt by rebel shareholders to oust the board, former Merrill Lynch banker and Yell chairman Bob Wigley was recruited as chairman last December.
At the time, he championed Sovereign's potential for expansion, due to the withdrawal of many competitors from the equity release market. Now, he is trying to fend off Grainger's 185p-a-share offer, which was rejected by Sovereign's board - despite being at a 50 per cent premium to its previous closing price. Sovereign's shares predictably rocketed by 25 per cent in one day.
Both parties are now "in dialogue" and shareholders in Sovereign - which include FT Money columnist John Lee - are rubbing their hands in anticipation. However, if Grainger pulls off this deal then its shares, currently changing hands for 135p, could also be a rewarding investment.
With a market value of £563m, Grainger is the UK's largest listed residential landlord and controls a portfolio of 20,000 properties in the UK and Germany. Leased on long-term tenancy agreements, when occupants move out or die, Grainger can refurbish properties and sell them on the open market.
Last year, Grainger raised £238m through a placing and rights issue to reduce gearing and shore up its balance sheet. It has ploughed cash into a series of acquisitions. Trading near current net asset value (NAV) of 140p, JP Morgan real estate analyst Harm Meijer reckons that there is embedded property value of a further 38p per share - ignoring the impact of future house price increases.
As for Sovereign, even at today's inflated price it trades at a 26 per cent discount to last-published NAV of 220p. If the tenanted properties it owns were available for sale today, Sovereign's directors claim these have an "embedded value" of 413p a share (though obviously, they may not reach the market for 20 years or more).
A further caveat to such "embedded" figures is that home reversion providers have no right to enter the properties prior to taking possession, so they really have no idea what state they are in. Often, there is no central heating, and bathrooms and kitchens are outmoded, so substantial refurbishment costs have to be factored in.
One of the reasons few analysts cover either company is because sales volumes and margins are so tricky to forecast. Nevertheless, Grainger is admired by the City - not just because it is the only listed residential player in town, but because its management are respected experts in their field. Managing residential tenancies is a politically and socially sensitive business to be in. However, Grainger's ultimate reward is a much better yield than the paper-thin margins on conventional buy-to-let investments.
It should also be noted that Nick Leslau, the property mogul behind Aim-traded Max Property, took a £234m bet on equity release in 2007. He struck a derivative deal with reinsurer Swiss Re on a portfolio of 3,400 homes spread across the UK which are connected to equity release policies, gaining exposure to house price inflation over the 10-year trade.
When the properties are sold, his company Prestbury will be entitled to a share of the upside. Considering the average age of the tenants is 85, Leslau should be able to fund a comfortable early retirement of his own with the proceeds.
