Editing Regional REIT (section)

== Inflation hedge characteristics ==
In Exhibit 2, Edison Investment Research showed the relative stability of the income returns generated by RGL. A similar pattern has historically been evident for portfolio returns<ref>The return generated at portfolio level before the impact of gearing and excluding corporate costs.</ref> across the broad commercial real estate sector, although with a lower average level of income return. Edison Investment Research therefore believes it reasonable to expect medium-term rental growth to broadly match inflation. Over shorter periods, this may not be the case as the relationship will be influenced by the incidence and nature of rent reviews as well as the timing of lease maturities. For RGL, it is the relationship between office rents and inflation that is key, and Edison Investment Research discusses this in detail below.

Returning to the broad commercial property sector, as inflation rates have increased, investment flows into those companies with long, inflation-linked leases have remained strong. These generally provide a high level of income growth certainty and although indexed rent increases are typically capped at around 4%, below current inflation levels, this does have the additional advantage of ensuring rent levels remain affordable to tenants.

An alternative perspective is that shorter-term, open-market leases with a typical term of five years to first break provide an opportunity for landlords to rebase rents towards market levels, which may further adjust for inflation. Good-quality properties, attractive to tenants, with affordable rents, and low capital values relative to replacement cost should have the capacity to benefit from open-market rental growth to mitigate the impacts of inflation. RGL’s portfolio exhibits many of these characteristics, is likely to benefit from a sustained return to the office, and benefits from material rent reversion potential based on existing rent levels. RGL’s weighted average lease length at end-FY21 was 4.8 years or 3.0 years to first break. In the current year, leases accounting for £8.1m/11% of gross contracted rental income expire or £14.1m/20% including tenant break options.
{| class="wikitable"
|+Exhibit 6: Lease expiry profile by gross contracted rental income (end FY21)<ref>Source: Regional REIT.</ref>
!Year
! colspan="3" |Lease expiry
! colspan="2" |Lease expiry to first break
|-
!
!£m
!%
! colspan="2" |£m
!%
|-
|2022
|8.1
|11%
| colspan="2" |14.1
|20%
|-
|2023
|9.7
|14%
| colspan="2" |16.9
|24%
|-
|2024
|8.7
|12%
| colspan="2" |14.7
|21%
|-
|2025
|7.5
|11%
| colspan="2" |8.2
|12%
|-
|2026
|6.4
|9%
| colspan="2" |6.6
|9%
|-
|2027
|5.6
|8%
| colspan="2" |2.0
|3%
|-
|2028
|5.7
|8%
| colspan="2" |1.1
|2%
|-
|2029
|6.9
|10%
| colspan="2" |1.8
|2%
|-
|2030+
|12.0
|17%
| colspan="2" |5.3
|7%
|-
|'''Total'''
|'''70.6'''
|'''100%'''
| colspan="2" |'''70.6'''
|'''100%'''
|}

=== Reversionary upside adds to income potential ===
The externally estimated rental value (ERV) of RGL’s office portfolio was £86.3m at end-FY21, £22.4m or 35% above contracted rents,<ref>For the portfolio as a whole, ERV of £94.6m was similarly £22.5m ahead of £72.1m of contracted rent.</ref> representing significant potential to increase income. Most of this reversionary income potential (c £17m) related to occupancy improvement and the balance relates to the gap between existing rents and ERV as well as lease incentive run-off.

Although leasing activity has been challenging through the pandemic, it has begun to recover and RGL expects this to accelerate as the ‘return to the office’ gathers pace and as post-pandemic models for office usage become clearer. During Q122, RGL completed a number of lease renewals, achieving average rental uplifts of 13.6% versus previous rents and an average 11.7% uplift against ERV. Of the 44 units that came up for renewal in the period, 31 remain let (70.5%). Since 1 January 2022, it has exchanged on 20 new leases which, when fully occupied, will provide c £1.0m pa of rental income.