Small offices in the Midlands may not offer the glitz and glamour of gleaming towers in central London, but these properties do offer far superior expected returns. Indeed, office-focused property firm Real Estate Investors (RLE), which has 96 per cent of its assets in the Midlands, including 28 per cent in Birmingham, looks set to capitalise on buoyant demand in the region with forecast total returns (dividend yield plus NAV growth) of 10 per cent a year. While Brexit means considerable uncertainty exists about the property market's prospects, we feel a 28 per cent discount to forecast net asset value (NAV) and an expected dividend yield of over 7 per cent more than compensates for any angst.
Attractive dividend yield
Shares trade at a discount to net asset value
Very defensive business model
10 per cent total returns forecast
Growing competition for high-yielding assets
Lack of investor confidence
An unsatisfactory Brexit outcome is a real risk, and the company has sensibly positioned itself to capitalise on a market downturn should it occur. Its near-£8m cash and unused debt facilities give it about £30m of buying power. The idea here is to have the firepower to pick up assets at knockdown prices. In fact, acquisitions in the first half amounted to just £7.6m, although these were keenly priced at a net initial yield of 7.66 per cent, or 8.31 per cent were all leases negotiated up to today's market rents – the so-called reversionary yield.
Contracted rental income in the first half of 2018 was down slightly from a year earlier at £15.8m, which was partly as a result of disposals, but also because of lease terminations, allowing refurbishment that should mean space can be re-let on superior terms – a key focus for the company. Occupancy was still a healthy 92 per cent, down from 94 per cent, reflecting the favourable supply and demand balance in the region. On this basis, there is estimated to be £1.6m of rental value (a tenth of current rent) from void space within the existing portfolio.
| REAL ESTATE INVESTORS (RLE) | ||||
| ORD PRICE: | 54.5p | MARKET VALUE: | £102m | |
| TOUCH: | 53-56p | 12-MONTH HIGH: | 62p | LOW: 52p |
| FWD DIVIDEND YIELD: | 7.5% | |||
| DISCOUNT TO FORWARD NAV: | 28% | |||
| INVESTMENT PROP: | £214m | NET DEBT: | 63% | |
| Year to 31 Dec | Net asset value (p) | Net operating income (£m) | Earnings per share (p) | Dividend per share (p) |
| 2015 | 64.5 | 6.7 | 0.7 | 2 |
| 2016 | 66.2 | 11.4 | 2.8 | 2.6 |
| 2017 | 68.9 | 12.6 | 3.3 | 3.1 |
| 2018* | 71.7 | 14.1 | 3.6 | 3.6 |
| 2019* | 75.2 | 15.2 | 4.1 | 4.1 |
| % change | +5 | +8 | +14 | +14 |
| Normal market size: | 5,000 | |||
| Beta: | 0.44 | |||
| *Liberum forecasts adjusted NAV and EPS figures. Last IC view:Buy, 54.5p, 17 Sep 2018 | ||||
The portfolio also includes around 250,000 square feet of potential ‘permitted development’ conversion from office to residential use. Terms have already been agreed for the sale of an office scheme for residential development, and this will be value enhancing because residential values sit at a premium to office valuations.
Crucially, there is a highly experienced management team in place that benefits from an extensive relationship network. This is extremely important because it can lead to more off-market acquisitions, whereby the company doesn’t have to enter into a competitive bid situation. Even so, competition for high-yielding assets is steadily on the increase.
While there is some exposure to the retail sector in the portfolio, the focus here is on convenience and neighbourhood outlets. The forecast of annual 10 per cent total returns, which are from broker Liberum, are chiefly based on the outlook for income, with the quarterly-paid dividend fully covered by earnings. These returns look very attractive compared with Colliers International forecast all-property returns of 5.8 per cent this year, dropping to 3.8 per cent in 2019.
