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Smart deal making by a trio of property companies has yet to be priced into their valuations
August 22, 2022

It’s worth keeping an eye on boardroom changes as they can be highly informative as to the direction a company is heading.

A good example is Palace Capital (PCA:283p), a high-yielding regional commercial property Reit. Having taken feedback from its shareholders, Palace changed tack and is now focused on maximising cash returns (‘A royal investment opportunity’, 20 July 2022). The new strategy is one of liquidation, hence why property director Richard Starr has just stepped down from his role. His duties will be spread between the group’s heads of asset management and investment. Neil Sinclair, chief executive and co-founder, stepped down from the board earlier in the summer.

Palace looks firmly in play. Indeed, the board “remains mindful of consolidation in the real estate sector as part of its considerations.” Bearing this in mind, analyst Colin Smith at house broker Arden Partners notes that “recent consolidation transactions in the sector have been announced at four to seven per cent discounts to net asset value (NAV).”

However, Palace’s share price is priced 29 per cent below proforma NAV of 397p. The potential for property disposals and mergers & acquisitions activity to narrow the share price discount to NAV is under-priced, as is the case with another one of my sector picks.

Circle Property’s liquidation gathers pace

  • Contracts exchanged for sales of buildings K1, K2 and K3 at Kents Hill Business Park
  • Sale agreed for disposal of properties in Birmingham and Staines

Circle Property (CRC:248p), an internally managed Jersey-registered property company, has exchanged contracts to sell Kents Hill Business Park, located next to the Kents Hill Conference Centre, Milton Keynes, for £17.2mn, a 10 per cent premium to its March 2022 carrying value.

The sale of the first two buildings has already completed, raising £12.7mn, with the third building due to complete in the final quarter following refurbishment. The three properties were acquired for £11mn in 2013 and produced a pre-tax profit of £0.56mn in the last financial year.

In addition, Circle has exchanged contracts on the sales of Cheltenham House, Temple Street, Birmingham, comprising 16,469 sq ft of office and restaurant space, and Elizabeth House, London Road, Staines, a 14,829 sq ft office building. Both disposals will complete next month to raise gross proceeds of £8.2mn, equivalent to their March 2022 combined carrying value.

On completion of all the above property disposals, Circle should have proforma net cash of around £29mn (101p a share) and retain five remaining properties which have a book value of £51.9mn (181p a share).

The directors are targeting a triple net asset value (NAV) of 275p a share on completion of the liquidation process, and plan to make the first of two capital returns by March 2023. However, high specification modern office fit-outs of Concorde Business Park, Maidenhead and 36 Great Charles Street, Birmingham have improved both properties’ ESG credentials and letting interest from potential tenants, so there is scope for rental income growth to support valuation uplifts. Also, the liquidation process could be materially shorter than the 18 to 24-month original plan.

Circle’s shares have delivered a 25 per cent total return since I first suggested buying (Alpha Research: ‘A deep value property play’, 21 February 2020) during which time the FTSE Aim All-Share index has shed 3.7 per cent of its value. A further 10 per cent share price upside over the next 12 months is a reasonable expectation with expected cash returns to shareholders improving the risk-adjusted return. Buy.

 

First Property pulls off smart property deals

  • Acquisition of additional 32.1 per cent share in prime office building in Warsaw
  • Lease of 1,115 sq metres of office building in Gdynia, Poland
  • Profit of €1.16mn on sale of Tureni warehouse for €3.6mn

Aim-traded UK and eastern European property fund manager and investor First Property (FPO: 30p) has completed the purchase of a further 7,171 square metres (32.1 per cent share) of a prime office building in Warsaw, Blue Tower to take its ownership to 17,937 sq metres (80.3 per cent).

First Property already owned 48 per cent of the building, which generated net operating income of €1.25mn (£1.06mn) and carried a valuation of €18.2mn (£15.4mn) at 31 March 2022. The additional 7,171 sq metres of space has been purchased for 40.4mn zlotys (£7.2mn) of which £1.07mn has been paid up front, five annual instalments of £0.9mn will be paid between 2023 and 2027, and the balance of £1.7mn is due in 2028. It’s a smart deal.

Just over 2,000 sq metres of space is already leased out at £0.24mn to Pekao Bank on a rolling termination lease with first break in February 2024 at the earliest, while 5,159 sq metres is void after another banking tenant vacated. It will cost €300 per sq metre to refurbish, but First Property negotiated a discount on the asking price to cover a third of the refurbishment cost.

Importantly, new supply in the Warsaw market is grinding to a halt (due to the surge in the cost of building materials and labour rates) in what remains a tight market as the country’s economy continues to expand. The backdrop means that office rents are likely to surge over the next 12 to 18 months as new supply coming onto the market fails to meet ongoing occupational demand. The phasing of the consideration payable means that the refurbishment programme can be managed as new tenants are signed up. Taking into account refurbishment costs, the additional space acquired would still generate a 10 per cent yield on purchase price based on the rent Pekao Bank is paying, but clearly there is potential for a material uplift in rents given the dynamics at work.

It’s not the only smart deal First Property has done. Having purchased an almost vacant 13,400 sq metre vacant office property in prime central Gdynia, Poland’s second largest seaport after Gdansk, paying €4m upfront and financing the €16mn purchase with a €12mn interest-free loan maturing in June 2024, the group has already leased out 28 per cent of the property.

A fifth of the building is let to the District Court in Gdynia, and a further 1,115 sq metres of space has just been let to a legal tenant who will take occupation in January following a fit-out. It means that annual rent and service charges exceed €0.8mn, reducing the operating loss on the building to only €30,000. Once fully let, the building should yield a rent of €2.1mn and a further €0.4mn in service charges, a healthy return on the €16mn purchase price. Similar market dynamics are at work in Gdynia as Warsaw, while having the District Court as anchor tenant is clearly attracting interest from other legal advisers and practitioners.

Importantly, First Property is in a healthy financial position, and is also reaping hefty gains from disposals. It has just sold a warehouse in Tureni for £3.05mn, realising a hefty £1mn profit, of which £2.14mn will be used to paydown the group’s low-cost debt (all non-recourse). An office block in Bucharest and three mini-supermarkets in Poland are up for sale, too, and could realise £11mn, well above their combined book value of £8.4mn. If all four sales materialise then First Property's pro-forma free cash could swell to around £16.5mn (15p a share), a sum that covers 75 per cent of the group’s gross borrowings of £21.5mn (19.4p a share).

However, investors have yet to cotton onto the upside from First Property’s dealmaking as the £33.3mn market capitalisation company is priced 37 per cent below its last reported net asset value (NAV) of £53.4mn (47.3p a share). Moreover, both the Gdynia and Blue Tower properties (aggregate book value of £28.8mn, or 25p per share) offer valuation upside, while equity interests in funds managed (book value of £30.6m, or 27p a share) are rock solid investments.

Although the share price is unchanged since I covered the annual results (‘Bargain Shares: On the hunt for undervalued high yielding property’, 23 June 2022), there is compelling value on offer here. Buy.

 

Simon Thompson was named Journalist of the Year at the 2022 Small Cap Awards.

■ 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 at £16.95 each plus postage and packaging. Details of the content can be viewed on www.ypdbooks.com.

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