Workspace is a smart property play

Chief executive Harry Platt describes Workspace as "an income earning landbank" and it is certainly logical to think about the London-centric real estate investment trust (Reit) in these terms. As the landlord to over 4,000 small businesses in the capital, Workspace's property portfolio boasts workshops and studios in revamped art-deco factories, 1960s office blocks and inner-city industrial estates - all close to transport hubs - offering cheap, flexible and well-designed space.

Such properties are not likely to surge in value, but have latent value through changing planning consents. In the last financial year, three disposals of re-planned sites (to student housing, residential and self-storage uses) fetched £15m, a £5m premium to book value. And the company has identified a further £12m of disposals. Moreover, with an average book value of £126 per sq ft, compared with a replacement cost of £140 per sq ft, the portfolio is lowly rated. The value on offer is even more apparent measured on a net asset value (NAV) basis, as Workspace's shares are trading almost 30 per cent below broker Execution Noble's March 2011 NAV estimate - one of the deepest discounts in the sector. So why are its shares so cheap? The answer is nervousness about the "income" part of Workspace's property equation.

The last two years have proved the defensive merits of its London-centric business model. Like-for-like occupancy rates at its centres has risen to 84.7 per cent (up from 82.9 per cent a year ago) and enquiries remain buoyant, with the company continuing to receive an average of 1,000 approaches a month. However, deals have been secured at the cost of softer rents, as management think it is better to reduce pricing than see significant voids arise. Historically, occupancy needs to hit 90 per cent for rents to rise meaningfully. If this is achieved, at estimated rental values, the company's annual cash rent roll could be boosted by £9m to nearly £60m. In the near term, the state of London's small business economy is more of a concern and, although bad debts from failed tenants remain low, the flexible leases mean it's easy for tenants to downsize, or walk away.

Workspace has also been doing some smart deals lately. Last December, following a £19m equity issue, the company bought back control of its Glebe joint venture from HBOS after joint-venture partner Glebe Two was placed into liquidation. The acquisition of 18 freehold properties instantly added 1.5p a share to NAV. "We sold these properties into the joint venture for £150m in 2006, and effectively bought them back at half price," says Mr Platt. Tenants had lived with nine months of uncertainty about the partnership's future, but occupancy and rental income has already been improved.

The company remains comfortably within its banking covenants and the refinancing of an onerous loan from GE Real Estate should complete within the next four weeks with a new group of lenders, giving Workspace access to cheaper debt since the interest rate on the current facility will rise by 100 basis points in August.