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Opportunities in property

Our small-cap stock picking experts highlights three value commercial property plays and sees an investment opportunity in a company exiting Aim.
Opportunities in property

My 2018 Bargain Shares Portfolio has produced a market beating 95 per cent total return since launch – FTSE All-Share and FTSE Aim All-Share indices have produced TR of 10.4 and 21.5 per cent, respectively, in the same 40-month period – but it has been far from plain sailing. That’s because the Covid-19 pandemic has wreaked havoc in the real estate sector and sent shares in my property holdings, property vulture fund Conygar (CIC) and regeneration land developer U+I (UAI) tumbling, so much so that the two holdings have reduced the portfolio’s TR by 6.5 percentage points.

Asset impairments have not helped sentiment, but the subsequent recovery in share prices in both companies since the start of this year would indicate that investors are now taking a more positive view of the road ahead rather than being fixated on last year’s crash. In both cases this is a justified approach as I outline in my financial results summaries below. The same is true of student accommodation and buy-to-rent apartment developer Watkin Jones (WJG). The doubling of the company’s share price since last autumn is fully warranted, but it’s decision time given the price has achieved my target range.


U+I’s new board outlines recovery plan

  • Appointment of new finance director and chief executive in 2021.
  • Net debt and operating costs materially reduced.
  • Focus on fewer number of large scale mixed-use regeneration projects.
  • Pipeline of non-core asset sales to slash borrowings further.

U+I (UAI:90p) new chief executive Richard Upton, the group’s former chief development officer and founder of specialist regeneration developer Cathedral Group, which was itself acquired by U+I in 2014, has wasted no time in restructuring the developer’s operations since taking the reins in January 2021.

Net debt has been slashed from £130m to £72m following disposal of non-core assets, and the group is on track to deliver a further £80m of asset sales in the year to 31 March 2022. Balance sheet gearing of 35.5 per cent has been cut from 44.9 per cent since March 2021 and the target is to reduce it to 25 to 35 per cent by March 2022. Importantly, the strengthened cash position and reduced borrowings means that U+I has £63m of free cash and liquidity, so has funds available to focus on five key mixed-use regeneration projects: Mayfield in Manchester; Landmark Court, a 1.7-acre site in London’s Bankside that is being transformed to create 200,000 sq ft of office space, shops, restaurants, and new homes; 8 Albert Embankment, London; Morden Wharf, Greenwich Peninsula; and Cambridge Northern Fringe East, a 47 hectare site, that’s being redeveloped to create 5,000 homes and 500,000 sq. ft. of office/ lab space. These schemes have a gross development value (GDV) of £6bn, and are projected to generate £1.4bn cumulative gross profit margin, so will be developed in partnership with patient capital providers.

The deleveraging of U+I’s balance sheet means that net debt is well below the £95m carrying value of the group’s investment portfolio which was valued on a net initial yield of 6.4 per cent, albeit capital values declined by £18.9m in the financial year, a reflection of the retail exposure. The group also booked £39m of development and trading losses, mainly due to asset write-downs.

House broker Liberum is penciling in a small operating loss for the current financial year and operating profit of £17.7m the year after when a return to the dividend list (5.4p a share) is forecast. On this basis, analysts expect net asset value (NAV) per share to bottom out at 150p in March 2022, from 163p in March 2021, implying the shares are trading on a 40 per cent discount to forward book value. Positive planning news on 8 Albert Embankment and Morden Wharf mixed-use schemes in the next three months should narrow that valuation gap. Recovery buy.


Nottingham’s Island Quarter development a hidden gem

  • Conygar’s NAV flat in past six months.
  • Modest write-down on Cross Hands retail park.
  • InterContinental Hotels agrees to manage 223-bedroom hotel at Island Quarter.

Conygar (CIC:122p) continues to make decent progress developing its 40-acre Island Quarter site in Nottingham that was formerly Boots HQ. Located close to the train station, Conygar submitted a detailed planning application in January for the first phase which will encompass a 223-bedroom hotel to be managed by InterContinental Hotels under its Hotel Indigo brand, 247 residential apartments and 3,000 sq metres of flexible office space. A detailed planning application for the second phase was submitted earlier this month for a 702-bed student accommodation scheme. Nottingham has a chronic shortage of student accommodation, so much so that students are travelling in each day from towns as far away as Derby. Subject to planning approval, Conygar’s directors hope to have the scheme up and running for the start of the 2023 academic year.

Conygar acquired the Nottingham site for £13.5m in December 2016 and it’s carried in the books at cost (£26.9m, or 51p a share), accounting for 43 per cent of the group’s £62.2m (118p) portfolio of investment and development properties. The £1bn scheme has potential to generate material gains for Conygar’s shareholders, but with a £600m total construction cost then external funding is needed given that Conyar has net cash of £23.9m (45.5p). A joint venture partnership is the most likely option alongside asset sales and debt funding. Expect news on this front later this year.

Potential asset sales include Cross Hands retail park in Carmarthenshire which has a book value of £15.85m (30p), slightly lower than six months ago. It has traded well through the pandemic with exception of a small store let to Peacocks which went into administration in November. The conditional sale of an industrial property in Selly Oak, Birmingham, to a well-known listed student accommodation provider, is pending subject to an imminent planning decision. If planning consent is approved, Conygar should realise around £7m (13p) net of fees, or double its purchase price in April 2019.

So, with the combined value of cash on the balance sheet, the conservatively valued Nottingham site, Cross Hands and Selly Oak, accounting for 139p of Conygar’s 164p NAV, the shares are well underpinned. Positive news flow from the planning applications and financing discussions on Island Quarter later this year have scope to narrow the valuation gap materially, not to mention highlight the hidden value in the balance sheet. Recovery buy


Watkin Jones’s solid trading prospects

  • Development pipeline up from £1.5bn to £1.6bn since January update.
  • New sites acquired in Edinburgh and Swansea.
  • Increase in institutional demand for student accommodation and build-to-rent housing.

Shares in Watkin Jones (WJG:236p), a developer specialising in purpose-built student accommodation (PBSA) and build-to-rent (BTR) housing, have continued to recover strongly this year and earlier this month achieved the top end of my 240p to 250p target range (‘Watkin Jones recovering strongly’, 19 January 2021). First half results to 31 March 2021 were in line with analyst expectations which point to high-single digit growth in annual pre-tax profit, earnings per share (EPS) and dividend to £50m, 15.8p and 7.8p, respectively.

Of far more relevance to me is that institutional demand for BTR hit a record £1.23bn in the first quarter of 2021, highlighting a strong recovery in confidence following last year’s Covid-19 induced market softness. Watkin Jones is developing 5,008 apartments which have a GDV of £950m, including a site in Edinburgh (524 flats) that was secured after the 31 March half-year end. It’s easy to see why the asset class is proving attractive to investors.

Across the UK, occupancy levels are above 90 per cent, rent collection rates have exceeded 95 per cent since the start of the pandemic, and with household sizes forecast to reduce by 2.4 per cent by 2041, there will be a need for an extra 240,000 homes in the next 20 years. Also, BTR residential property provides a hedge against inflation and a widening yield gap over 10-year government bond yields, thus offering decent prospects for both capital and income growth in a zero-interest rate policy environment. The directors note that their Leicester scheme (185 flats) has been brought forward to the current year and the marketed pipeline of forward sales is proceeding well.

They also flag up that institutional investment in PBSA, around £715m in the first quarter of 2021, is well above pre-Covid-19 levels. The group is developing 8,500 beds with a GDV of £625m, of which all 3,192 beds for delivery in the current year have been forward sold as well as 60 per cent of next year’s output, too.

The profits earned from developing properties for institutional investors – BTR has a targeted profit margin of 15 per cent and PBSA 20 per cent – combined with an asset light business model – the investor funds the development, thus de-risking the investment case – means that the board can continue to recycle excess cash flow back to shareholders. Indeed, analysts at Progressive Equity expect a near 10 per cent hike in the 2022 dividend to 8.5p a share, covered two times by forecast EPS of 17.4p. On this basis, the shares are still only rated on a forward cash-adjusted PE ratio of 11.6, and offer a prospective dividend yield of 3.6 per cent. I raise my target price to 275p. Buy.


Urban Exposure plans cash return and delisting

  • Planned delisting on 23 June 2021.
  • Cash return of 31.6p by 6 July 2021.
  • Further cash return of 40p to 43p within 12 months.

Specialist residential development finance provider and asset manager Urban Exposure (UEX: 65p) is seeking shareholder approval on 22 June to delist its shares from Aim and appoint a liquidator to wind down the balance of the company’s loan portfolio. The plan is to make an initial cash distribution of 31.6p a share by 6 July and further cash returns of 40p to 43p within 12 months. The company returned £65m through a tender offer at 75p at the start of 2021.

The 31.6p a share initial cash return will account for £22.8m of Urban Exposure’s £31.3m (43p a share) cash pile and further pay-outs will be dependent on liquidating £22.5m loan receivables (31p a share). The total cost of the liquidation is £790,000, a reasonable amount. Effectively net of the initial cash distribution on 6 July, shareholders can expect a return of between 16 and 25 per cent of their remaining investment, a decent return for holding equity in an unlisted company.

I suggested buying the shares in my March 2019 Alpha Report and the holding has a break-even point of 60p after adjusting for cash returns to date. I would advise voting in favour of the de-listing and liquidation.


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