The track record of the investment team behind Alpha Real Trust (ARTL:184.5p), a £110m market capitalisation company that invests in high-yielding property and asset-backed debt and equity investments, is outstanding. Since I first spotted the company's potential ('High-yield property play', 10 Feb 2016), Alpha’s net asset value (NAV) per share has surged by 73 per cent to a record 213.5p, the board has paid out cumulative dividends of 10.6p a share, and the share price has risen by 130 per cent.
The board have also returned chunks of cash to shareholders including a capital return of £22.8m last summer through a tender offer at 175p a share, having reported eye-watering gains on the disposal of a data centre site in Frankfurt and the "Monk Bridge" residential development site in Leeds. The asset sales generated a total of £55.9m in cash proceeds which helped boost Alpha’s NAV per share by 17 per cent in the 2018/19 financial year, and left the company with a cashed up balance sheet.
The plan is to ramp up Alpha’s high-yielding secured senior debt and mezzanine finance lending activities on UK real estate investment and development assets in order to generate a higher proportion of attractive income returns rather than holding assets for capital gains. It should result in the share price discount to NAV narrowing markedly to complement shareholder returns from a healthy stream of quarterly dividends.
At the end of last year, Alpha’s portfolio of first and second charge secured property loans was worth £51m. It generates annual weighted average income returns of 11.8 and 15.1 per cent, respectively. Each loan typically has a term of up to two years, and a maximum loan-to-gross development ratio of 75 per cent. The aim is to increase lending to £85m of Alpha’s £123m investment portfolio.
Lucrative lending area
It makes sense to do so given that major high street banks continue to shun this area of the lending market mainly due to regulations which have made development finance more onerous in terms of additional Tier 1 capital requirements. Indeed, development finance loans are 150 per cent risk weighted regardless of the borrower’s sophistication, asset quality and any de-risking factors, meaning that the risk appetite for this asset class is significantly reduced.
Other constraints on bank lending include conduct requirements on senior directors and officers of the bank which require banks to demonstrate deep and detailed procedures relating to the origination and project monitoring of property development finance loans. Banks may be able to demonstrate an ability to properly originate a property development loan, but they are not always set up to manage the monitoring of them.
Moreover, under accounting standard IFRS9, banks are required to provide for more stringent credit loss positions. This is impacting regulatory capital requirements because they need to reflect any increase in the expected credit loss position in addition to any capital charges incurred as a result of existing credit losses.
So, although there are profitable investment opportunities to exploit for small and medium sized property development companies, their ability to take advantage of them has been constrained due to a lack of development finance, hence the reason why Alpha can make such high risk-adjusted return on this lending activity. Alpha reports a strong pipeline of lending opportunities to target in this area.
Importantly, the company has the capital to scale up lending activities. Alpha’s cash of £22.6m at 30 September 2019 excluded £11.3m of cash held in a 100 per cent owned unencumbered fund, Alpha UK Property, which only has one industrial property to sell. Alpha is also pursuing the £4.9m sale of the Armouries residential development site it owns in Birmingham, which has planning consent for 162 residential units and ground floor commercial areas.
| Alpha Real Trust portfolio | |||||
| Investment name | Carrying value | Income return p.a. | Property type/underlying security | Investment notes | Portfolio weighting |
| High return debt (38.6%) | |||||
| Secured senior finance | £26.5m | 11.8% | Diversified loan portfolio focused on real estate investments and developments. | Senior secured debt. | 21.5% |
| Secured mezzanine finance | £21.0m | 15.1% | Secured mezzanine debt and subordinated debt. | 17.1% | |
| High return equity in property investments (36.0%) | |||||
| H2O shopping centre | £19.5m | 5.7% | Dominant Madrid shopping centre and separate development site. | 30 per cent shareholding; medium term moderately geared bank finance facility. | 15.8% |
| Long leased industrial facility, Hamburg | £7.0m | 7.0% | Long leased industrial complex in major European industrial and logistics hub. | Long term moderately geared bank finance facility. | 5.7% |
| Alpha UK Property Fund Asset Company (No 2) | £16.2m | 8.9% | High-yield commercial UK portfolio. | 100 per cent shareholding; no external gearing. Holds cash of £11.3m. | 13.1% |
| Cambourne Business Park | £1.7m | 10.0% | High-yield business park located in Cambridge. | Medium term moderately geared bank finance facility. | 1.4% |
| Other investments (7.1%) | |||||
| Unity and Armouries, Birmingham | £4.5m | n/a | Central Birmingham residential build-to-rent. | Planning consent for 90,000 sq ft / 162 units plus commercial. Sale agreed for £4.9m. | 3.7% |
| Galaxia | £4.0m | n/a | Development site located in Delhi. | Legal process underway to recover investment by enforcing arbitration award. | 3.2% |
| Healthcare & Leisure Property Limited | £0.2m | n/a | Leisure property fund. | No external gearing. | 0.2% |
| Cash and short-term investments (18.3%) | |||||
| Cash and short-term investments (18.3%) | £22.6m | 0.1% | Excludes £11.3m of cash held in 100 per cent owned Alpha UK Property Fund (see entry in table above). | 18.3% | |
| Source: Alpha Real Trust interim accounts at 30 September 2019. | |||||
High-yielding property investments
Other major investments in Alpha’s portfolio include a 30 per cent stake worth £19.5m in the H2O shopping centre in Madrid. It has proved a shrewd investment as record visitor numbers (footfall up 6.6 per cent in the first nine months of 2019), strong like-for-like sales performance from tenants (up 8.2 per cent) and low voids (occupancy rates of 97 per cent by rental value) support an attractive 5.7 per cent yield on equity.
Alpha is also generating a decent return on an 11.8-acre freehold industrial facility close to Hamburg, Germany that was purchased for €16.7m (£14.8m) and is leased to industrial waste management group, Veolia. The annual passing rent of €900,000 (£800,000) has periodic inflation linked adjustments over the unexpired 24-year lease term, and the tenant is responsible for building maintenance. Alpha part funded the purchase through a €9.5m fixed rate 10-year loan (the only debt on its balance sheet), so earns a 7 per cent index-linked return on its £7m (€7.9m) equity. The investment offers potential for capital growth from an industrial location in a major German logistics and infrastructure hub.
Prospects for dividend hikes and capital gains
As the UK property lending book scales up then Alpha could easily make interest income north of £11m on an £85m property loan book at a blended rate of 13.3 per cent, a sum that covers the £3.8m annual running costs of the company and leaves surplus cash for further dividend hikes. Indeed, the cash cost is only £0.7m for the 1p a share quarterly payout. Moreover, there is a natural NAV accretive mechanism built into the shares from the double-digit investment returns made on property lending activities, and supplemented by capital upside on the equity interests in Madrid, Hamburg and a £1.7m equity investment in the high yielding Cambourne business park in Cambridge. Buy.
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Simon Thompson was named 2019 Small Cap Journalist of the year at the 2019 Small Cap Awards.
