The UK government’s Levelling-Up Fund is a positive for economic activity in the regions. Around £4.8bn has been earmarked for town centre and high street regeneration, local transport, cultural and heritage projects. The levelling up agenda will also see the government taking considerable office space in Manchester, Leeds, Liverpool, Wolverhampton, Birmingham & Darlington as departments move out of London.
The issue being that availability of Grade B and C office space across regional markets in England has fallen by 45 per cent since 2015. Excluding London, 31m sq ft of office space has been converted to residential under Permitted Development Rights in England. At the same time, there has been limited speculative regional office development, a key reason why the total available office supply has declined 17 per cent since the end of 2019.
This is clearly good news for property companies with a strong regional bias at a time when more London and South East based businesses will also be considering the relocation of some of their operations to generate cost savings, or implementing a 'hub and spoke' model with a greater regional presence to meet the demands of employees. One such company, Palace Capital, is a major beneficiary.
Targeting an under-rated Reit value play
- £14.9m of flats at Hudson Quarter sold, up from £12.5m in April.
- £9.4m of asset sales exchanged at above net asset value (NAV) since year-end.
- 14 new lettings at 16 per cent premium to estimated rental value (ERV).
- Quarterly payout hiked 20 per cent.
Shares in Palace Capital (PCA:250p), a regional commercial property Reit, have rallied 15 per cent since I initiated coverage (Alpha Research: ‘A Reit royal value play’, 11 March 2021). The re-rating is fully warranted.
Importantly, Palace has minimal exposure to retail property, with the sector accounting for only 7.6 per cent of the portfolio’s £282m valuation. Palace’s rental income from retail tenants accounts for 11.5 per cent of contractual rental income of £16.4m. The company doesn’t have high street retail exposure, but owns retail park properties which have strong covenants. For example, food retailer Aldi, building supply group Wickes and cash-and-carry retailing group Booker account for a combined £950,000 of annual rental income. Clearly, they are performing well. A portfolio bias towards regional offices (41 per cent portfolio weighting and no London exposure), industrial warehouses (14.4 per cent) and retail warehouses (3.3 per cent) support robust rent collection rates, too. In fact, Palace has collected 95 per cent of rents since the start of the pandemic, and concluded 14 new lettings at an average 16 per cent premium to ERV.
Moreover, the company has been selling off assets above book value. In the financial year to 31 March 2021, Palace disposed of £5.4m of non-core assets at a 23 per cent premium to NAV, and has since exchanged contracts on £9.4m of the £30m targeted disposals for the new financial year at above book value, too. In addition, Palace has now sold 50 of the 127 apartments at its newly completed Hudson Quarter development in York for £14.9m, and expects to realise a further £17.5m from 37 more sales by next March.
So, with net debt equating to 42 per cent of the £282m investment portfolio, the cash inflow should enable Place to target opportunistic property purchases while at the same time rewarding loyal shareholders. The board have raised the quarterly dividend by 20 per cent to 3p a share, covered 1.3 times by EPRA EPS of 15.7p, implying a 4.8 per cent dividend yield.
As disposals are made at above book value, and the company lets out its high-quality low-rent regional commercial office space as the UK economy recovers (average rent below £20 per sq ft), it’s only reasonable to expect valuation uplifts, and a further narrowing of the 27 per cent discount to EPRA NAV of 343p. By comparison, Liberum Capital’s peer group of 19 UK commercial property companies trade on an average discount of only 6.1 per cent and offer an identical dividend yield. Buy.
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