Investment case strengthens for high-yielding AEW UK Reit

AEW UK Reit (AEWU: 96p) flagged up its results in its last quarterly update (‘A smart way to play UK commercial property’, 4 May 2023), but events since then suggest the investment case has strengthened.

At the 31 March 2023 financial year-end, AEW owned a £214mn portfolio of 36 regional UK commercial property assets focused on industrial property (44.2 per cent), retail warehouses (20.5 per cent), high-street retail (18.7 per cent), offices (7.2 per cent) and other real estate (9.4 per cent). In the 12-month period, the four sectors outperformed AEW’s Benchmark by 10.9 per cent in terms of capital performance, with each segment delivering relative income outperformance, too.

So, although the yield-expansion-driven markdown in property valuations led to a negative £30mn fair value movement on the portfolio, the 12.5 per cent fall in net asset value (NAV) per share to 105.5p was better than Liberum Capital’s 100p estimate. The portfolio valuation now embeds an EPRA net initial yield (NIY) of 7.65 per cent, up from 5.87 per cent at 31 March 2022. The yield expansion was driven by the sharp rise in government bond yields in the past 12 months.

Post-period-end disposals at premium prices

That’s worth noting because AEW has just completed the sale of two industrial assets in Bradford and Leeds for a total of £16.1mn, or 12.5 per cent above the most recent valuation. The exit prices have added 1.2p per share to AEW’s year-end NAV of 105.5p and reflect a blended NIY of 6.2 per cent, suggesting that valuers have been too aggressive in their markdowns in the 2023 accounts. Clearly, investors in the real world are willing to pay significantly higher open-market prices as last month AEW also offloaded another industrial asset for £4.75mn, or 8 per cent above carrying value.

AEW’s investment manager is proving adept at making shrewd acquisitions as part of an ongoing capital recycling programme that led to £44.4mn of disposals and £32mn property acquisitions in the 2022-23 financial year. For instance, the purchase of a top-10-performing UK Matalan store in Preston in late March this year reflected a low capital value of £110 per sq ft and reversionary yield of 10.7 per cent.

Furthermore, factoring in the £20.85mn proceeds from the post-period-end industrial property disposals, pro-forma net debt of £25mn equates to 13 per cent of the £195mn portfolio valuation. AEW has a low-cost £60mn credit facility that runs until May 2027, so the investment manager has ample firepower and expects to announce further purchases of high-yielding property in the coming months.

So, having upgraded AEW’s shares to a buy, at 97p, ahead of the annual results, and with the portfolio conservatively valued, I feel that it’s worth locking into the 8.4 per cent dividend yield and exploiting the unwarranted 10.5 per share price discount to spot NAV of 106.8p. Buy.

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