Bargain Shares: On the hunt for undervalued high yielding property

“In adversity comes opportunity”, says Ben Habib, chief executive of Aim-traded UK and eastern European property fund manager and investor First Property (FPO: 31p).

In particular, the property stalwart sees the “Warsaw office market as a terrific spot to be in as new supply is coming to a thumping halt [in a tight market] and the economy continues to expand.” Habib sees “rents in Poland’s capital city going up substantially in the next 12 to 18 months”, and notes that a doubling of building costs is accentuating the crunch in the market at a time when Ukranian businesses are being forced to relocate their operations.

Bearing this in mind, First Property already owns 48 per cent of a prime office building in Warsaw, Blue Tower, which generates net operating income of €1.25mn (£1.1mn) and carries a valuation of €18.2mn. I can reveal that the group has just signed a deal to buy a further 7,000 square metres of space that a banking tenant recently vacated for 40.5mn zlotysw (£7.45mn). The additional space accounts for 32 per cent of Blue Tower and will cost €300 per sq metre to refurbish, but First Property negotiated a €0.75mn discount on the asking price to cover a third of the total refurbishment cost.

Moreover, the group is only paying €1.3mn cash upfront with the balance of the consideration payable over the next five years, so the refurbishment programme can be managed as new tenants are signed up. First Property has also been given access to start the refurbishment programme during the lengthy legal process to complete the acquisition. It looks a smart deal.

The same is true of the group’s purchase of a 13,400 sq metre vacant office property in prime central Gdynia, Poland’s second largest seaport after Gdansk. The area has benefited from considerable investment in recent years. First Property paid ING €4m upfront and financed the €16mn purchase with a €12mn interest-free loan that matures in June 2024.

The group has already leased out 20 per cent of the space, the majority of which is let to the District Court in Gdynia, and has a further 1,000 sq metres of space in negotiations. Enquiries from potential tenants are “healthy” as other legal advisers and practitioners look to take space. Once fully let, the property should generate €2.5mn of rent and service charges, an income stream that equates to 15.6 per cent of the €16mn purchase price and one that should underpin a 50 per cent higher property valuation. Habib notes that Gdynia has a low vacancy rate in office space, and is benefiting from the same market dynamics as Warsaw.

During our results call, Habib also revealed that First Property is looking to exit its two directly held Romanian properties (an office block in Bucharest and warehouse in Tureni) for more than 70 per cent above their combined book value of £3.9mn, as well as three mini-supermarkets in Poland (book value of £6.4mn based on a yield of 8.5 to 9 per cent). An exit yield of 6.5 to 8 per cent should be achievable, says Habib, suggesting further valuation uplifts. The capital will then be recycled into new property purchases, mainly in Poland to exploit the opportunity there.

New house broker Allenby Capital has yet to initiate coverage, so there are no forecasts in the market. But First Property could potentially realise £15.5mn or more on the five disposals (book value of £10.4mn) to boost its free cash to £22mn, a sum that almost equates to the group’s gross borrowings (all non-recourse) of £23.6mn.

On this basis, the Gdynia and Blue Tower properties (combined book value of £28.8mn, or 25p per share), and equity interests in 11 of the 13 funds First Property manages (book value of £30.6m, or 27p a share) are effectively in the price for 40 per cent below book value even though there are catalysts to create shareholder value. It also means that you get a free ride on a fund management business that is earning annualised fee income of £2.7mn (excluding performance fees) from £517mn of third party funds under management.

Although First Property’s share price has drifted nine per cent since I covered the interim results (‘Bargain Shares: Priced for a profitable outcome’, 24 November 2021), this is a strong outperformance of the FTSE Aim All-Share Total Return index which has shed 26 per cent of its value in the same period. More importantly, the combination of disposals at a significant premium to book value, new lettings and property acquisitions should act as catalysts to markedly narrow the unwarranted 35 per cent share price discount to NAV. Buy.

■ Simon Thompson's latest book Successful Stock Picking Strategies and his previous book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. The books are being sold through no other source and are priced at £16.95 each plus postage and packaging of £3.25 [UK].

Promotion: Subject to stock availability, both books can be purchased for the promotional price of £25 each plus £3.95 postage and packaging

They include case studies of Simon Thompson’s market beating Bargain Share Portfolio companies outlining the investment characteristics that made them successful investments. Simon also highlights many other investment approaches and stock screens he uses to identify small-cap companies with investment potential. Details of the content can be viewed on www.ypdbooks.com.