Grainger is building into a sector with high demand

Residential landlord Grainger (GRI) still wants to become a real estate investment trust (Reit) – with a plan to reach the threshold of generating 75 per cent of its profits from rental revenue rather than home sales in two-and-a-half years. Doing so would give the company a generous tax break and be a boon for investors who will, as per Reit rules, see at least 90 per cent of its taxable income as dividends.

However, being a Reit rather than a housebuilder comes with its downsides. Holding onto homes as revenue-generating assets rather than inventory for sale means being stung by valuation slumps – which is precisely what has happened to Grainger in its results for the six months to 31 March. Even though it posted a 12 per cent increase in net rental income, this was offset by a £40.2mn valuation hit caused by higher interest rates, which slashed its pre-tax profit by 94 per cent.

This drop in value has been combined with an increase in its debt, which looks particularly perilous in a period of high interest rates. The company points out that much of this debt is fixed at a low rate for six years, but further growth is likely to come at the expense of more debt and Grainger does not have a huge amount of headroom in that regard.

There are three caveats to this bearish picture. The first is increasing dividends combined with a commitment to become a Reit, which will make generous dividend payments a requirement. The second is that the value of Grainger’s portfolio of residential assets has not been hit as hard as commercial property assets. According to data firm MSCI, total return – property valuation and rent changes taken together – for UK commercial property was down 13 per cent for the year to 31 March, whereas Grainger recorded a 2 per cent increase in net tangible asset value and a 6.8 per cent increase in like-for-like rent over the same period.

The final bull point for Grainger is demand. Residential rents are increasing at their fastest pace on record thanks to a shortage of available homes. This is a big part of the reason why analyst Oxford Economics predicts that residential property will far outperform all commercial property segments in the coming years – on both valuation and rent increases. 

So, while Grainger is heavily leveraged, it is building into a property sector with demonstrable demand and a strong potential for valuation increase. No small feat at a time when many property companies are struggling. Buy.