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Index-linked leases help spark LXI uplift

Pent-up demand has resulted in investors piling back into UK real estate
November 24, 2021
  • Investor demand for inflation-linked leases picks up
  • Valuations tick up in every part of the commercial landlord’s portfolio

A week may be a long time in politics, particularly when it starts with a rambling speech about Peppa Pig World. Similarly, the usually gradual world of commercial property investment has crammed in what feels like a lifetime of change into the past 20 months. From missed rents and fears of tenant defaults, the sector has lurched to questions about asset viability and, finally, surging economic recovery.

The latter has had several impacts on LXI Reit (LXI), as the 4.9 per cent rise in the value of the group’s portfolio in the six months to September shows. For one, pent-up demand has resulted in investors piling back into UK real estate, where yields on prime long-income assets still look attractive against some geographies, including Western Europe.

That has in turn led to some yield compression across the assets LXI holds. But in a period of heightened concern around inflation, the landlord's largely index-linked portfolio is more attractive than most. Throw in re-gearing in the pub portfolio – where average leases have been extended from 13 to 20 years – and the capitalising of rental growth, and you get a total net asset value (NAV) return of 9 per cent in six months.

Might this be further improved by reweighting the portfolio toward certain sectors? John White, one of the Reit’s two fund managers, says this is the wrong way to think about LXI’s investment style. For example, the decision to forward fund a Lok’nStore store in Essex was less about building exposure to self-storage – strong as the sector’s credentials are – but because the investment presented itself as a “good quality covenant at a healthy discount”.

This philosophy also helps explain why Secure Income Reit (SIR), whose sector-agnostic investment portfolio includes Travelodges and Alton Towers, was keen to explore a tie-up during the period. While those discussions have been discontinued, it may just be a question of when.

White’s colleague Simon Lee – himself no stranger to theme parks, having also enjoyed a recent trip to Peppa Pig World – did not rule out a future merger, if it proved accretive to shareholders. He added that he and his team “highly respect” Secure Income’s management, but suggested that timing and LXI’s belief in its own capacity to grow independently won out during due diligence.

Longer term, competition from well-resourced US-based Reits might well spark consolidation among smaller scale operators. For now, LXI’s rising and inflation-protected rental income increases the prospect that Peel Hunt’s adjusted NAV forecast of 143p for March 2023 can be beaten. Buy.

Last IC View: Hold, 105p, 20 May 2020

LXI REIT (LXI)    
ORD PRICE:148.6pMARKET VALUE:1bn
TOUCH:147.4-148.8p12-MONTH HIGH:150pLOW: 113p
DIVIDEND YIELD:5.8%TRADING PROP:£21m
PREMIUM TO NAV:9.7%NET DEBT:25%
INVESTMENT PROP:£1.2bn   
Half-year to 30 SepNet asset value (p)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p)
2020121-4.00-0.8+2.65
202113673.611.3+3.00
% change+12--+13.2
Ex-div: 2 Dec*   
Payment: 30 Dec*   
*Relates to second quarterly dividend of 1.5p. Q1 dividend was paid on 29 Oct.