Lock in an 8% yield with this industrial Reit

AEW UK Reit (AEWU:97p) is making solid progress recycling the £21mn proceeds from the disposal of three industrial properties and has made another disposal at a significant premium to book value, too.

In the summer, AEW paid £10m for a well-located 0.8-acre site within York City Wall, encompassing a 297-space carpark let to National Car Parks (NCP) and 100,000 square feet of retail and office space leased to five tenants. The car park generates three-quarters of the income from the asset with the lease benefiting from a 2027 rent review. It will see rent increasing in line with the uncapped retail price index, resulting in a forecast reversionary yield of more than 10 per cent.

AEW also acquired a 51,632 sq ft retail and office property in Bath city centre for £11.5mn on a net initial yield (NIY) of 8 per cent. The property has a low passing rent of £22 per sq ft, thus offering scope for positive rent uplifts on rent review in the short term or re-lettings in the medium term. Both purchases highlight the investment manager’s strategy of targeting assets with reversionary potential, which will be accretive to earnings.

Post the half-year end, AEW sold a high-street retail property in Portsmouth for £3.9mn, or 22 per cent above the previous carrying valuation. Although the NIY of 9.9 per cent seems high, the fully let property is overrented and there is a risk that the main tenant, Nationwide Building Society, will vacate when its lease expires in 2029. As a result, the valuation of the property is likely to deteriorate, so it made sense to sell now and recycle the capital into AEW’s pipeline of higher-performing assets.

Lettings and acquisitions enhance earnings

Importantly, income from the acquisitions will cover the shortfall on the 2p-a-share quarterly dividend, which was uncovered by quarterly European Real Estate Association (EPRA) earnings per share (EPS) of 1.84p. Progress on lettings and rent reviews is helping, too, as highlighted by three notable rent increases across three industrial properties.

It’s worth noting that the £219mn property portfolio is lowly geared. The interest rate on the £60mn fully drawn debt facility is fixed at 2.96 per cent until May 2027, so it makes sense to recycle cash from disposals into higher-yielding reversionary assets rather than paying down debt. That’s because it not only frees up cash after debt servicing costs to pay a quarterly dividend that has been held for 32 consecutive quarters, but property valuations would have to decline by almost 50 per cent for the loan covenant to be breached.

That’s not going to happen as three-quarters of the book is invested in industrials (35.7 per cent), retail warehouses (21.1 per cent) and high-street retail (17.4 per cent), sectors that have enjoyed rental growth over the past 12 months and have seen valuations stabilise after enduring negative yield shift induced movements in the fourth quarter of 2022.

So, having suggested buying the shares, at 97p, over the summer (‘Investment case strengthens for high-yielding AEW UK Reit’, 26 June 2023), the 8.2 per cent dividend yield is worth locking in given that valuations have stabilised, asset management initiatives are boosting rental income and sound progress is being made in capital recycling to rebuild dividend cover. 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 at £16.95 each plus P&P of £3.75, or £25 plus P&P of £5.75 for both books.