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New ways to play the property recovery

A number of niche property companies have sprung up to capitalise on the real estate revival. Which should you buy?
September 25, 2014

With the revival in UK commercial real estate now firmly entrenched, it’s hardly surprising that interest has switched from those areas already in top gear, such as central London, to what were previously considered investment graveyards. To harness the scope for a recovery in capital values, real estate investment companies (Reits) have been springing up. Investor demand has been strong, with shares on offer through a spate of initial public offerings (IPOs) being snapped up with little hesitation.

Bottom-fishing in Dublin

One theme has been bottom-fishing in bombed-out markets. Perhaps the most notable area identified for its recovery potential is Ireland, and specifically Dublin. Rents in the city are starting to grow again for prime office space. They are now ticking along at around €45 (£36) per square foot - still well below the €65 levels achieved ahead of the financial crash. The business plan, for the most part, is to invest in prime sites with a relatively short lease. These can then be sympathetically refurbished, or at the very least re-let at significantly higher rates.

There is no shortage of supply. The National Asset Management Agency (NAMA) - which was set up in December 2009 as part of a government initiative to address the problems facing banks weighed down by an excess of non-performing property loans - has so far made sales of €19bn, but still has another €12bn on its books. And banks would probably like to unload a similar amount to reduce leverage.

With capital flooding into the market, competition for assets has inevitably started to warm up. But there still seems to be room to achieve capital appreciation. Green REIT (GRN), for example, has spent the past year acquiring Dublin offices at an average initial rental yield of 7.8 per cent. Capital appreciation since has taken the average yield on the portfolio down to 6.7 per cent, as at 30 June. But that's still well above pre-crisis yields, or indeed current office yields in other capital cities.

 

Three newcomers

Green raised €710m through an initial public offering in July last year and a secondary offering in May. In the period to June it invested €365m, with further commitments of €383m. The €28.5m rent roll is set to jump to €52.2m after completion of all the acquisitions under contract. It also has a 50 per cent stake in a portfolio known as Central Park. Based on a self-imposed loan-to-value ceiling of 35 per cent, it has room to invest a further €300m.

Another slightly smaller newcomer is Hibernia REIT (HBRN). Having raised €365m on flotation last year, by July this year it had invested €267m, primarily in the central Dublin office sector. The office space is 99 per cent occupied on an average contracted rent of €33 per sq ft. This is some way below the €40-45 per sq ft levels that prime central Dublin office space now fetches. Crucially, the management team has an extensive network of contacts, which means it can secure off-market deals. This is important because it means the company can avoid going through the process of making competitive bids when assets come onto the open market.

Meanwhile, IRES REIT (IRES) - Ireland’s first dedicated residential real estate investment trust - was floated earlier this year. Formerly a wholly owned subsidiary of Canadian Apartment Properties Real Estate Investment Trust, IRES began operations in September 2013, when it acquired a portfolio of multi-unit residential rental properties in Dublin. Earlier this year it bought an additional portfolio of 761 apartments from NAMA for €211m. The Dublin housing market is still in the early stages of recovery, not least because of the supply imbalances brought about by the absence of any significant newbuild activity.

Niche property in Britain

With interest rates still at nominal levels, investors have also embraced property vehicles focused on income. This is perhaps also because the real estate market is a cyclical beast, and the one way to ensure getting hurt is to be short on income and long on development projects when the downturn arrives - though nothing like this looks likely for some time yet.

The level of investor interest is highlighted by the ease with which fresh finance is being raised. Tritax Big Box REIT (BBOX) is a good example. Floated last December, the group raised £200m at an issue price of 100p (now 107p). A follow-up equity fundraising in June produced an additional £20.8m. This was followed by a placing and open offer in July, which was oversubscribed and raised a further £150m.

As the name implies, Tritax specialises in very large logistics warehouse assets. While the interim rent roll was a modest £5.7m, recent purchases will push that up to £24.9m. There is also a dividend. The payout for 2014 should be around 4.15p a share, according to the company. Broker Jefferies reckons that could grow to 6.43p next year - giving a yield of 6 per cent.

Secure Income REIT (SIR), which floated on AIM as recently as June, makes its raison d'être clear in its name. Backed by the same team as Max Property (MAX), it owns the freehold on £1.46bn of assets including Madame Tussauds, Alton Towers, Thorpe Park and Warwick castle, as well as 21 private hospitals. Almost all of the rental income is paid by two global businesses, Merlin Entertainments (MERL) and Ramsey Health Care, and is running at around £94m a year. The big plus point is that all the leases have annual rental uplifts, while the average unexpired lease term is 25 years. But the shares are tightly held and there's unlikely to be a dividend before 2016.

A final niche area of the property market that has attracted interest is student accommodation. The number of students in Britain is expected to rise significantly when the government finally removes its cap on overseas students coming to the UK. Empiric Student Property (ESP) was floated in June this year, raising £85m, of which it has already spent over £70m on acquiring student accommodation in major regional centres such as Birmingham, Aberdeen, Exeter and Southampton. Some of these will require conversion: the Buccleuch Street site in Edinburgh, for example, is part of a listed former cinema. As development projects carry much more risk, however, these will be restricted to 20 per cent of the company’s gross asset value.

Empiric is the second real-estate investment trust to focus on student property. The first was London-focused GCP Student Living (DIGS), which raised £70m via a flotation in May 2013 and a further £42m in April this year. It confirmed this month that its property portfolio is fully occupied for the 2014-15 academic year, with a 3.6 per cent average uplift in rent per room over the previous year.

IC view:

Property companies went through the shredder in the financial crash for two reasons: too much debt and overweight development portfolios. But the crash also created opportunities for a new generation of companies to exploit. The latest batch - offering recovery stories on the one hand, and low-risk income plays on the other - has much to offer. Particularly the more regional Reits, including those in Ireland, have significant untapped potential for both capital and rental growth.

Favourites:

Clearly the market in Dublin is ripe for both capital appreciation and higher rental income, giving companies such as Green REIT and IRES REIT a double attraction. Commercial property values only started to record modest growth last year after a six-year nightmare that saw values fall by about two-thirds. With both companies picking up assets with a big reversionary gap - where current rents are much lower than wider market levels - the outlook for the next couple of years at least looks exciting.

Outsiders:

Investors can afford to be choosy, given the wide range of investment opportunities on offer. So companies that will take time to pay out dividends, such as Secure Income (SIR), seem less attractive - even though its portfolio of properties is top quality.