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Return to the office gathers momentum.
== Summary ==
== Summary ==
This note focuses on the outlook for income-driven returns from Regional REIT (RGL). With the ‘return to the office’ accelerating, RGL expects a positive demand-supply balance to generate rental growth, increased occupancy and valuation gains. Q122 DPS increased c 3% to 1.65p. Income risk is mitigated by portfolio diversification, while fully fixed or hedged borrowing costs protect against further interest rate increases.
This note focuses on the outlook for income-driven returns from Regional REIT (RGL). With the ‘return to the office’ accelerating, RGL expects a positive demand-supply balance to generate rental growth, increased occupancy and valuation gains. Q122 DPS increased c 3% to 1.65p. Income risk is mitigated by portfolio diversification, while fully fixed or hedged borrowing costs protect against further interest rate increases.
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'''Valuation: High yield and fully covered DPS'''
'''Valuation: High yield and fully covered DPS'''


Reflecting the potential impact of a deteriorating political and economic environment, Edison Investment Research has reduced its EPRA earnings forecasts by c 2% and the fully covered FY22 DPS to 6.6p (from 6.7p). This continues to reflect an attractive yield of 7.9% while the shares trade at a 14% discount to NAV.
Reflecting the potential impact of a deteriorating political and economic environment, we have reduced our EPRA earnings forecasts by c 2% and the fully covered FY22 DPS to 6.6p (from 6.7p). This continues to reflect an attractive yield of 7.9% while the shares trade at a 14% discount to NAV.


== Income-led total returns ==
== Income-led total returns ==
RGL came to market in November 2015 targeting a higher yield portfolio that would provide progressive, regular dividends with the potential for capital growth. Active asset management and capital recycling are key elements in sustaining asset yields. RGL’s dividend yield has been consistently one of the highest in the sector and quarterly dividends were maintained during the pandemic, albeit at a reduced level. Aggregate FY21 DPS of 6.5p was up 1.6% on FY20 (6.4p) and Q122 DPS of 1.65p has increased c 3% versus Q121, an annualised rate of 6.6p. Although RGL has typically paid three equal quarterly dividends followed by a higher Q4 dividend, Edison Investment Research has trimmed its FY22 fully covered DPS forecast to 6.6p from 6.7p previously. This may prove to be conservative but recognises the deterioration in the global economic and political environment. For FY23, Edison Investment Research forecasts a fully covered 6.9p (previously 7.1p).
RGL came to market in November 2015 targeting a higher yield portfolio that would provide progressive, regular dividends with the potential for capital growth. Active asset management and capital recycling are key elements in sustaining asset yields. RGL’s dividend yield has been consistently one of the highest in the sector and quarterly dividends were maintained during the pandemic, albeit at a reduced level. Aggregate FY21 DPS of 6.5p was up 1.6% on FY20 (6.4p) and Q122 DPS of 1.65p has increased c 3% versus Q121, an annualised rate of 6.6p. Although RGL has typically paid three equal quarterly dividends followed by a higher Q4 dividend, we have trimmed our FY22 fully covered DPS forecast to 6.6p from 6.7p previously. This may prove to be conservative but recognises the deterioration in the global economic and political environment. For FY23, we forecast a fully covered 6.9p (previously 7.1p).
{| class="wikitable"
{| class="wikitable"
|+Exhibit 1: NAV total return performance<ref>Source: Regional REIT data, Edison Investment Research. Note: *NAV is defined as EPRA net tangible assets (NTA) per share.</ref>
|+Exhibit 1: NAV total return performance<ref>Source: Regional REIT data, Edison Investment Research. Note: *NAV is defined as EPRA net tangible assets (NTA) per share.</ref>
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|5.8%
|5.8%
|}
|}
Accounting total return<ref>The change in EPRA NTA/NAV plus dividends paid.</ref> has been positive in each year since listing other than in FY20 due to the pandemic. Total return up to end-FY21 amounts to 41.2% or an average annual return of 5.8%. Reflecting RGL’s strong income focus, its returns have all been generated by dividends paid with a good level of consistency, as shown in Exhibit 2.
Accounting total return1 has been positive in each year since listing other than in FY20 due to the pandemic. Total return up to end-FY21 amounts to 41.2% or an average annual return of 5.8%. Reflecting RGL’s strong income focus, its returns have all been generated by dividends paid with a good level of consistency, as shown in Exhibit 2.
 
'''Exhibit 2: Trend in dividend return and capital return'''<ref>Source: Regional REIT data, Edison Investment Research.</ref>
 
[[File:Trend in dividend return and capital return.png|600px]]


With its Q122 update, RGL announced the introduction of a dividend reinvestment plan, the details of which are available on its website.
With its Q122 update, RGL announced the introduction of a dividend reinvestment plan, the details of which are available on its website.
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In addition to monitoring the industry exposure of tenants (and prospective tenants when assessing acquisitions) at the broad sector level, RGL also undertakes detailed analysis based on Standard Industrial Classification (SIC) codes.
In addition to monitoring the industry exposure of tenants (and prospective tenants when assessing acquisitions) at the broad sector level, RGL also undertakes detailed analysis based on Standard Industrial Classification (SIC) codes.
'''Exhibit 4: Income diversified by industry exposure (end FY21)'''<ref>Source: Regional REIT.</ref>
[[File:Income diversified by industry exposure (end FY21).png|600px]]


== Protected against increasing interest rates ==
== Protected against increasing interest rates ==
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|101.3%
|101.3%
|}
|}
Interest rate risk is virtually eliminated<ref>There is a small interest rate exposure on the c £66m notional value of caps which we estimate represents a maximum uplift to total borrowing costs of c 4bp.</ref> with a weighted average effective interest rate, including hedging costs, of 3.4% at end-Q122. Net loan to value ratio (LTV) was 40.3%<ref>Net borrowings as a percentage of the FY21 externally assessed property value adjusted for subsequent property transactions and capex.</ref> at end-Q122, a reduction from 42.4% at end-FY21, primarily benefiting from disposals in the period. Gross borrowings were £434.1m and cash and equivalent balances were £82.3m.
Interest rate risk is virtually eliminated2 with a weighted average effective interest rate, including hedging costs, of 3.4% at end-Q122. Net loan to value ratio (LTV) was 40.3%3 at end-Q122, a reduction from 42.4% at end-FY21, primarily benefiting from disposals in the period. Gross borrowings were £434.1m and cash and equivalent balances were £82.3m.


== Inflation hedge characteristics ==
== 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.
In Exhibit 2 we showed the relative stability of the income returns generated by RGL. A similar pattern has historically been evident for portfolio returns4 across the broad commercial real estate sector, although with a lower average level of income return. We therefore believe 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 we discuss 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.
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.
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=== Reversionary upside adds to income potential ===
=== 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.
The externally estimated rental value (ERV) of RGL’s office portfolio was £86.3m at end-FY21, £22.4m or 35% above contracted rents,5 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.
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.
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The relatively high yield on RGL’s office assets (reversionary yield of 9.6% at end-FY21 or net initial yield of 5.4%) is a key element of income generation and dividend strategy. In its capital markets webinar in November 2020 (available on RGL’s website), the asset manager emphasised that this high yield is not an indication of low asset quality. RGL’s sector strategy is to target the provision of high-quality regional offices, fit for national, multinational and regional companies of all sizes, in a cost-effective manner. Because these assets are not typically prime/grade A, they are often referred to as ‘secondary’. RGL challenges the usefulness of this phraseology, believing that it overlooks the high quality of most of the assets – built to a high specification, with raised access floors, air conditioned and refurbished to a high standard within the past 10 years. The asset manager believes these could be reasonably and better described as ‘grade A- or B’. For those assets it considers A-, achieved rents are 40–50% lower than for similar quality prime/grade A, although they are likely to be in more peripheral locations or well-located business parks. For those assets considered grade B, the gap to prime/grade A assets is 50–70%, while remaining very suitable and functional for most occupiers.
The relatively high yield on RGL’s office assets (reversionary yield of 9.6% at end-FY21 or net initial yield of 5.4%) is a key element of income generation and dividend strategy. In its capital markets webinar in November 2020 (available on RGL’s website), the asset manager emphasised that this high yield is not an indication of low asset quality. RGL’s sector strategy is to target the provision of high-quality regional offices, fit for national, multinational and regional companies of all sizes, in a cost-effective manner. Because these assets are not typically prime/grade A, they are often referred to as ‘secondary’. RGL challenges the usefulness of this phraseology, believing that it overlooks the high quality of most of the assets – built to a high specification, with raised access floors, air conditioned and refurbished to a high standard within the past 10 years. The asset manager believes these could be reasonably and better described as ‘grade A- or B’. For those assets it considers A-, achieved rents are 40–50% lower than for similar quality prime/grade A, although they are likely to be in more peripheral locations or well-located business parks. For those assets considered grade B, the gap to prime/grade A assets is 50–70%, while remaining very suitable and functional for most occupiers.


Edison Investment Research expects the key office portfolio statistics to be broadly similar to the position at the time of the webinar, all low-rise assets, mostly (62%) located in business parks, with an additional c 6% on the edge of towns. Low-rise offices that are less reliant on lift facilities and assets with good parking facilities, enabling staff to drive to work comfortably and avoid public transport, may well benefit in a post COVID-19 environment. Significantly driven by office working trends resulting from the pandemic, there is a ‘flight to quality’ underway across the sector. Additionally, the need to enhance the environmental performance of buildings, and maintain their attractiveness, has become a significant consideration for landlords and occupiers alike.
We expect the key office portfolio statistics to be broadly similar to the position at the time of the webinar, all low-rise assets, mostly (62%) located in business parks, with an additional c 6% on the edge of towns. Low-rise offices that are less reliant on lift facilities and assets with good parking facilities, enabling staff to drive to work comfortably and avoid public transport, may well benefit in a post COVID-19 environment. Significantly driven by office working trends resulting from the pandemic, there is a ‘flight to quality’ underway across the sector. Additionally, the need to enhance the environmental performance of buildings, and maintain their attractiveness, has become a significant consideration for landlords and occupiers alike.


== Enhancing sustainability ==
== Enhancing sustainability ==
RGL’s ESG Working Party was formed in 2020. In addition to preparing the company’s sustainability policy and its relevant key performance indicators, in 2021 the working party oversaw its response to the Task Force on Climate-Related Financial Disclosures (TCFD) and prepared its first GRESB Standing Investment Assessment. The first GRESB assessment resulted in RGL being awarded one green star and, building on this work, the 2022 GRESB submission is currently in progress. RGL is additionally working towards an EPRA Sustainability Best Practice report and continues to engage with accredited bodies with the intention of ensuring that all relevant data are taken into consideration by them.
RGL’s ESG Working Party was formed in 2020. In addition to preparing the company’s sustainability policy and its relevant key performance indicators, in 2021 the working party oversaw its response to the Task Force on Climate-Related Financial Disclosures (TCFD) and prepared its first GRESB Standing Investment Assessment. The first GRESB assessment resulted in RGL being awarded one green star and, building on this work, the 2022 GRESB submission is currently in progress. RGL is additionally working towards an EPRA Sustainability Best Practice report and continues to engage with accredited bodies with the intention of ensuring that all relevant data are taken into consideration by them.


Within its overall ESG framework, RGL is targeting an EPC rating<ref>Energy Performance Certificate.</ref> of B or better for all properties by 2030. To this end, it is undertaking a portfolio-wide updated EPC audit, following which individual EPC property plans will be revised and implemented. RGL already requires an independent environment report for all potential acquisitions.
Within its overall ESG framework, RGL is targeting an EPC rating6 of B or better for all properties by 2030. To this end, it is undertaking a portfolio-wide updated EPC audit, following which individual EPC property plans will be revised and implemented. RGL already requires an independent environment report for all potential acquisitions.
{| class="wikitable"
{| class="wikitable"
|+Exhibit 7: 2021 EPC ratings<ref>Source: Regional REIT. Note: *Other includes areas that are non-rated, in most cases reflecting recently acquired or earmarked for disposal.</ref>
|+Exhibit 7: 2021 EPC ratings<ref>Source: Regional REIT. Note: *Other includes areas that are non-rated, in most cases reflecting recently acquired or earmarked for disposal.</ref>
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Since it listed in November 2015, RGL’s consistent strategy has been to build a highly diversified portfolio of higher-yielding investments in the regions, outside the M25 motorway which, including gearing (target LTV of c 40%), would provide progressive, regular dividends with the potential for capital growth. Active asset management and capital recycling are key elements in sustaining asset yields. RGL seeks to acquire under-managed properties where there are opportunities to create additional value through lease renewals and rent increases, minimising voids through effective marketing of vacant space, enhancing the tenant mix and covenant strength, and through refurbishment, extension or change of use. When properties have met their return objectives they are assessed for sale (or to hold if their income and capital growth outlook looks strong). By definition, capital recycling tends to suppress reported occupancy but provides the opportunity to reallocate resources to new value-creating investments.
Since it listed in November 2015, RGL’s consistent strategy has been to build a highly diversified portfolio of higher-yielding investments in the regions, outside the M25 motorway which, including gearing (target LTV of c 40%), would provide progressive, regular dividends with the potential for capital growth. Active asset management and capital recycling are key elements in sustaining asset yields. RGL seeks to acquire under-managed properties where there are opportunities to create additional value through lease renewals and rent increases, minimising voids through effective marketing of vacant space, enhancing the tenant mix and covenant strength, and through refurbishment, extension or change of use. When properties have met their return objectives they are assessed for sale (or to hold if their income and capital growth outlook looks strong). By definition, capital recycling tends to suppress reported occupancy but provides the opportunity to reallocate resources to new value-creating investments.


Exhibit 8 shows the extent of capital recycling, which Edison Investment Research notes is determined primarily by asset management plans and not trading. The reversionary yield on the portfolio, which assumes full occupancy and market-level rents, has been consistently in the range or 9% or more. Lower occupancy and increased non-recoverable property costs reduced the net initial yield in FY21, although the reversionary yield increased.
Exhibit 8 shows the extent of capital recycling, which we note is determined primarily by asset management plans and not trading. The reversionary yield on the portfolio, which assumes full occupancy and market-level rents, has been consistently in the range or 9% or more. Lower occupancy and increased non-recoverable property costs reduced the net initial yield in FY21, although the reversionary yield increased.
 
'''Exhibit 8: Active capital recycling'''<ref>Source: Regional REIT data, Edison Investment Research.</ref>


[[File:Active capital recycling.png|400px]]
While these core elements of strategy have remained unchanged, from late 2020 the company repositioned itself as a specialist regional office investor. This change of focus reflected RGL’s continuing positive outlook for relative returns in the regional office sector, and a desire to capitalise on the investment manager’s strong expertise and operational platform while providing a clear proposition to investors. The office sector now represents 91.4%7 of the portfolio by value compared with 58.4% at IPO. Also in line with post-IPO strategy, a significant c 35% weighting to Scotland has been reduced to c 17%, with a corresponding increase in England and Wales from c 65% to c 83%.
 
'''Exhibit 9: High portfolio yield maintained'''<ref>Source: Regional REIT data, Edison Investment Research.</ref>
 
[[File:High portfolio yield maintained.png|400px]]
 
While these core elements of strategy have remained unchanged, from late 2020 the company repositioned itself as a specialist regional office investor. This change of focus reflected RGL’s continuing positive outlook for relative returns in the regional office sector, and a desire to capitalise on the investment manager’s strong expertise and operational platform while providing a clear proposition to investors. The office sector now represents 91.4%<ref>As at Q122.</ref> of the portfolio by value compared with 58.4% at IPO. Also in line with post-IPO strategy, a significant c 35% weighting to Scotland has been reduced to c 17%, with a corresponding increase in England and Wales from c 65% to c 83%.
 
'''Exhibit 10: Sector positioning by value at IPO'''<ref>Source: Regional REIT.</ref>
 
[[File:Sector positioning by value at IPO.png|400px]]
 
'''Exhibit 11: Sector positioning by value at Q122'''<ref>Source: Regional REIT.</ref>
 
[[File:Sector positioning by value at Q122.png|400px]]


== Financial and portfolio overview ==
== Financial and portfolio overview ==


=== Portfolio overview ===
=== Portfolio overview ===
The portfolio was externally valued at end-FY21 at £906.1m and on a pro forma basis<ref>Adjusted for acquisitions, disposals and capex but excluding any revaluation.</ref> was c £874m at end-Q122. Q122 included £33.5m (before costs) of disposals. Subsequent transactions have taken the year-to-date total for disposals to £69.2m with acquisitions amounting to £48.2m. The blended net initial yield on disposals of 5.9% compares with 8.7% on acquisitions, locking in an accretive yield spread.
The portfolio was externally valued at end-FY21 at £906.1m and on a pro forma basis8 was c £874m at end-Q122. Q122 included £33.5m (before costs) of disposals. Subsequent transactions have taken the year-to-date total for disposals to £69.2m with acquisitions amounting to £48.2m. The blended net initial yield on disposals of 5.9% compares with 8.7% on acquisitions, locking in an accretive yield spread.
{| class="wikitable"
{| class="wikitable"
|+Exhibit 12: Key portfolio data<ref>Source: Regional REIT.</ref>
|+Exhibit 12: Key portfolio data<ref>Source: Regional REIT.</ref>
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|9.4%
|9.4%
|}
|}
Gross contracted rent roll was £68.5m at end-Q122, down from £72.1m at end-FY21, while EPRA occupancy was little changed at 81.6% versus 81.8%. Edison Investment Research estimates that the reduction in gross rent roll during Q122 was split broadly equally between disposals and additions to properties under refurbishment. The latter reduce the current rent roll but are excluded from EPRA ERV.
Gross contracted rent roll was £68.5m at end-Q122, down from £72.1m at end-FY21, while EPRA occupancy was little changed at 81.6% versus 81.8%. We estimate that the reduction in gross rent roll during Q122 was split broadly equally between disposals and additions to properties under refurbishment. The latter reduce the current rent roll but are excluded from EPRA ERV.


'''Positive FY21 return driven by fully covered dividends'''
'''Positive FY21 return driven by fully covered dividends'''


Results for the year to 31 December 2021 (FY21) were published on 29 March 2022. Exhibit 13 provides a summary of the FY21 financial performance. DPS increased from 6.4p to 6.5p and was fully covered by EPRA EPS of 6.6p. The period included the £236m (before costs) acquisition of the Squarestone portfolio, adding an initial £21.9m to annualised rent roll. Net property revaluation losses reduced significantly (from £56.1m to £7.7m) with like-for-like property valuation growth of 1.1% offset by £15.4m of property acquisition costs primarily the result of the Squarestone acquisition. Additionally, the fair value movement on interest rate hedging instruments swung from a £2.5m loss to a £6.0m gain because of rising market interest rates. As a result, IFRS net earnings were £28.8m versus a loss of £31.0m in FY21. Held back by property acquisition costs, EPRA net tangible assets (NTA) per share were slightly lower at 97.2p (FY20: 98.6p) but, including dividends paid, the accounting total return was 5.0%.
Results for the year to 31 December 2021 (FY21) were published on 29 March 2022 and were covered in our 4 April 2022 update note. Exhibit 13 provides a summary of the FY21 financial performance. DPS increased from 6.4p to 6.5p and was fully covered by EPRA EPS of 6.6p. The period included the £236m (before costs) acquisition of the Squarestone portfolio, adding an initial £21.9m to annualised rent roll. Net property revaluation losses reduced significantly (from £56.1m to £7.7m) with like-for-like property valuation growth of 1.1% offset by £15.4m of property acquisition costs primarily the result of the Squarestone acquisition. Additionally, the fair value movement on interest rate hedging instruments swung from a £2.5m loss to a £6.0m gain because of rising market interest rates. As a result, IFRS net earnings were £28.8m versus a loss of £31.0m in FY21. Held back by property acquisition costs, EPRA net tangible assets (NTA) per share were slightly lower at 97.2p (FY20: 98.6p) but, including dividends paid, the accounting total return was 5.0%.
{| class="wikitable"
{| class="wikitable"
|+Exhibit 13: Summary of FY21 financial performance<ref>Source: Regional REIT data.</ref>
|+Exhibit 13: Summary of FY21 financial performance<ref>Source: Regional REIT data.</ref>
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'''Relatively modest forecast reductions reflect global economic and political outlook'''
'''Relatively modest forecast reductions reflect global economic and political outlook'''


Edison Investment Research's previously published forecasts can be seen in Exhibit 14. Recognising the increased challenge to the UK growth outlook and accelerated inflationary environment, for RGL Edison Investment Research has slightly reduced forecast net rental income and slightly increased borrowing costs in respect of the small amount of variable rate debt that is hedged using caps rather than swaps. The Q122 average debt cost was 3.4% versus 3.3% at end-FY21. To maintain full dividend cover, Edison Investment Research has reduced its forecast FY22 DPS to 6.6p from 6.7p (FY21: 6.5p) and FY23 to 6.9p from 7.1p.
Our previously published forecasts can be seen in Exhibit 14. Recognising the increased challenge to the UK growth outlook and accelerated inflationary environment, for RGL we have slightly reduced forecast net rental income and slightly increased borrowing costs in respect of the small amount of variable rate debt that is hedged using caps rather than swaps. The Q122 average debt cost was 3.4% versus 3.3% at end-FY21. To maintain full dividend cover, we have reduced our forecast FY22 DPS to 6.6p from 6.7p (FY21: 6.5p) and FY23 to 6.9p from 7.1p.
{| class="wikitable"
{| class="wikitable"
|+Exhibit 14: Forecast revisions<ref>Source: Edison Investment Research.</ref>
|+Exhibit 14: Forecast revisions<ref>Source: Edison Investment Research.</ref>
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|(2.8)
|(2.8)
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|}
Edison Investment Research continues to assume no net acquisitions and disposals for the year, but within this reflect the year-to-date transactions and the positive yield spread that these have locked in.<ref>This includes £69.2m of reported disposals at a 5.9% net initial yield (NIY), £48.2m of reported acquisitions at an 8.7% NIY and c £20m of assumed acquisitions at an NIY of 8.5%.</ref> The driver of its forecasts is net rental income, where in FY22 and FY23 Edison Investment Research now assumes a slower benefit from letting activity but offset in FY22 by the positive impact of transactions. Edison Investment Research continues to forecast a relatively modest increase in EPRA occupancy<ref>The ERV of occupied space versus total ERV.</ref> (to c 84% by end-FY23) but note that this excludes properties under refurbishment and development. Edison Investment Research expects refurbishment activity to increase during the forecast period<ref>Our assumption of increased refurbishment activity has a positive impact on EPRA occupancy by reducing EPRA ERV, although the properties are unavailable to let during the period.</ref> as RGL continues to enhance the attractiveness of its assets and meet its energy performance targets, in line with sector trends.
We continue to assume no net acquisitions and disposals for the year, but within this reflect the year-to-date transactions and the positive yield spread that these have locked in.9 The driver of our forecasts is net rental income, where in FY22 and FY23 we now assume a slower benefit from letting activity but offset in FY22 by the positive impact of transactions. We continue to forecast a relatively modest increase in EPRA occupancy10 (to c 84% by end-FY23) but note that this excludes properties under refurbishment and development. We expect refurbishment activity to increase during the forecast period11 as RGL continues to enhance the attractiveness of its assets and meet its energy performance targets, in line with sector trends.


With EPRA earnings distributed in full and acquisitions and disposals matched by value, Edison Investment Research's property revaluation assumptions (1.5% pa gross of acquisition costs and capex) leave year-end LTV at approximately 42%. A reduction in LTV towards RGL’s medium-term target of c 40% would appear to require a stronger revaluation uplift than Edison Investment Research assumes or additional net property disposals. Revaluation gains may benefit from leasing progress and/or an improvement in external valuer sentiment as improving investment volumes provide more transactional evidence of underlying market valuations. Disposals would be likely to reduce the rental base.
With EPRA earnings distributed in full and acquisitions and disposals matched by value, our property revaluation assumptions (1.5% pa gross of acquisition costs and capex) leave year-end LTV at approximately 42%. A reduction in LTV towards RGL’s medium-term target of c 40% would appear to require a stronger revaluation uplift than we assume or additional net property disposals. Revaluation gains may benefit from leasing progress and/or an improvement in external valuer sentiment as improving investment volumes provide more transactional evidence of underlying market valuations. Disposals would be likely to reduce the rental base.


Edison Investment Research estimates that a 1% increase/decrease in the FY22e value of investment properties increases/decreases EPRA NTA by c 1.9%.
We estimate that a 1% increase/decrease in the FY22e value of investment properties increases/decreases EPRA NTA by c 1.9%.


== Valuation ==
== Valuation ==
Based on Edison Investment Research's FY22 DPS forecast of 6.6p, RGL provides a highly attractive 7.9% dividend yield, one of the highest in the sector, if not the highest.
Based on our FY22 DPS forecast of 6.6p, RGL provides a highly attractive 7.9% dividend yield, one of the highest in the sector, if not the highest.


In Exhibit 15, Edison Investment Research shows a comparison with a selected group of peers comprising mid-market diversified property investors and focused office sector investors, many of which are significantly larger than RGL with primarily central London exposure. To ease comparison, the data are based on 12-month trailing DPS declared and last published EPTA NTA/NAV. On this trailing basis (and Edison Investment Research forecasts on a prospective basis), RGL’s dividend yield continues to be at the very top end of both this selected peer group and the broad UK property sector (Edison Investment Research estimates c 4.0% on an unweighted trailing average basis). This is reflected in a narrower discount to NAV.
In Exhibit 15 we show a comparison with a selected group of peers comprising mid-market diversified property investors and focused office sector investors, many of which are significantly larger than RGL with primarily central London exposure. To ease comparison, the data are based on 12-month trailing DPS declared and last published EPTA NTA/NAV. On this trailing basis (and we forecast on a prospective basis), RGL’s dividend yield continues to be at the very top end of both this selected peer group and the broad UK property sector (we estimate c 4.0% on an unweighted trailing average basis). This is reflected in a narrower discount to NAV.
{| class="wikitable"
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|+Exhibit 15: Peer valuation and share price performance comparison<ref>Source: Company data, Edison Investment Research, Refinitiv prices as at 1 June 2022. Note: *Based on last reported EPRA NTA or NAV per share. **Based on trailing 12-month DPS declared.</ref>
|+Exhibit 15: Peer valuation and share price performance comparison<ref>Source: Company data, Edison Investment Research, Refinitiv prices as at 1 June 2022. Note: *Based on last reported EPRA NTA or NAV per share. **Based on trailing 12-month DPS declared.</ref>
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LSPIM is a privately owned co-investing asset management and property development business. Based in Glasgow, with regional offices in Leeds, Manchester and London, it has the resources to operate a fully integrated asset management platform, the benefits of which have been demonstrated by strong rent collection through the pandemic. The senior management team is highly experienced with a proven track record of adding value to property portfolios across cycles, through intensive property management, focusing on income generation.
LSPIM is a privately owned co-investing asset management and property development business. Based in Glasgow, with regional offices in Leeds, Manchester and London, it has the resources to operate a fully integrated asset management platform, the benefits of which have been demonstrated by strong rent collection through the pandemic. The senior management team is highly experienced with a proven track record of adding value to property portfolios across cycles, through intensive property management, focusing on income generation.


Management fees are set at 1.1% of net assets up to £500m and 0.9% above £500m, split equally between LSPIM and Toscafund. In addition, a property management fee of 4% of annual gross rental income is payable to LSPIM. An additional incentive is provided to the managers by way of a performance fee, set at 15% of total EPRA NAV per share return (EPRA NAV growth plus dividends declared) above an 8% hurdle, subject to a high-water mark. The performance fee is calculated annually and the intention is that one-third be paid in cash and two-thirds in shares (where new shares may be issued at above NAV). Performance fees were last accrued/paid during FY18; market conditions since have particularly suppressed capital returns. With the current high-water mark at 115.5p, Edison Investment Research does not anticipate performance fees being generated in the near term.
Management fees are set at 1.1% of net assets up to £500m and 0.9% above £500m, split equally between LSPIM and Toscafund. In addition, a property management fee of 4% of annual gross rental income is payable to LSPIM. An additional incentive is provided to the managers by way of a performance fee, set at 15% of total EPRA NAV per share return (EPRA NAV growth plus dividends declared) above an 8% hurdle, subject to a high-water mark. The performance fee is calculated annually and the intention is that one-third be paid in cash and two-thirds in shares (where new shares may be issued at above NAV). Performance fees were last accrued/paid during FY18; market conditions since have particularly suppressed capital returns. With the current high-water mark at 115.5p, we do not anticipate performance fees being generated in the near term.


At the FY21 AGM, Massy Larizadeh was appointed to the board of RGL with effect from 1 June 2022, its seventh member. She has over 30 years of experience across the financial services and commercial real estate sectors and, with a particular interest in environmental, social and governance issues, will act as chair to RGL’s ESG Working Party. The board is chaired by Kevin McGrath, a chartered surveyor with more than 30 years’ experience in the property sector and property asset management. Other members are William Eason, with extensive investment management and board experience; Daniel Taylor, founder and CEO of Westchester Capital, an investment and advisory firm specialising in real estate; Frances Daley, a chartered accountant with considerable experience in corporate finance and senior finance roles; Stephen Inglis (representing LSPIM) and Tim Bee (representing Toscafund).
At the FY21 AGM, Massy Larizadeh was appointed to the board of RGL with effect from 1 June 2022, its seventh member. She has over 30 years of experience across the financial services and commercial real estate sectors and, with a particular interest in environmental, social and governance issues, will act as chair to RGL’s ESG Working Party. The board is chaired by Kevin McGrath, a chartered surveyor with more than 30 years’ experience in the property sector and property asset management. Other members are William Eason, with extensive investment management and board experience; Daniel Taylor, founder and CEO of Westchester Capital, an investment and advisory firm specialising in real estate; Frances Daley, a chartered accountant with considerable experience in corporate finance and senior finance roles; Stephen Inglis (representing LSPIM) and Tim Bee (representing Toscafund).
Detailed biographies of all board members can be found here and we provide biographies for key members of the leadership team on page 14 of this report.


=== Principal shareholders ===
=== Principal shareholders ===
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== Sensitivities ==
== Sensitivities ==
The commercial property market is cyclical, historically exhibiting substantial swings in valuation through cycles. Income returns are significantly more stable, but still fluctuate according to tenant demand and rent terms. From a sector viewpoint, Edison Investment Research also highlights the increased risks and uncertainties that attach to development activity, including planning consents, timing, construction risks and the long lead times to completion and eventual occupation. RGL is not a developer but on a significantly lesser scale is exposed to similar uncertainties as it actively invests in improvements to existing assets with the aim of enhancing long-term income growth and returns. Edison Investment Research considers the main sensitivities to include:
The commercial property market is cyclical, historically exhibiting substantial swings in valuation through cycles. Income returns are significantly more stable, but still fluctuate according to tenant demand and rent terms. From a sector viewpoint, we also highlight the increased risks and uncertainties that attach to development activity, including planning consents, timing, construction risks and the long lead times to completion and eventual occupation. RGL is not a developer but on a significantly lesser scale is exposed to similar uncertainties as it actively invests in improvements to existing assets with the aim of enhancing long-term income growth and returns. We consider the main sensitivities to include:


* '''Economic risk:''' the war in Ukraine and sharply rising inflation, to a much lesser extent reflected in interest rates, are creating a high level of uncertainty regarding the global and UK economic outlook. Although the incidence and impact of the pandemic has substantially eased, there remains some uncertainty about the potential emergence of new strains.
* '''Economic risk:''' the war in Ukraine and sharply rising inflation, to a much lesser extent reflected in interest rates, are creating a high level of uncertainty regarding the global and UK economic outlook. Although the incidence and impact of the pandemic has substantially eased, there remains some uncertainty about the potential emergence of new strains.
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* '''Energy performance considerations:''' a failure to successfully meet regulatory and/or tenant expectations for energy performance enhancement would likely affect RGL’s ability to let properties on satisfactory terms and may make properties unlettable. In such circumstances, conversion to alternative use may offer mitigation.
* '''Energy performance considerations:''' a failure to successfully meet regulatory and/or tenant expectations for energy performance enhancement would likely affect RGL’s ability to let properties on satisfactory terms and may make properties unlettable. In such circumstances, conversion to alternative use may offer mitigation.
* '''Funding risks:''' RGL has a good spread of secured and unsecured borrowing facilities with no near-term maturities (first in August 2024) and an average duration of more than five years. All debt is fixed rate or hedged against rising interest rates. Any significant increase in long-term interest rates may be expected to negatively affect market-wide property valuations and hence LTV ratios as well as NAV.
* '''Funding risks:''' RGL has a good spread of secured and unsecured borrowing facilities with no near-term maturities (first in August 2024) and an average duration of more than five years. All debt is fixed rate or hedged against rising interest rates. Any significant increase in long-term interest rates may be expected to negatively affect market-wide property valuations and hence LTV ratios as well as NAV.
* '''Management risk:''' RGL is externally managed and is dependent on the ability of its asset manager to execute successfully on its strategy. Although Stephen Inglis, Derek McDonald and Simon Marriot, respectively CEO, managing director and investment director of the asset manager, LSPIM, are significantly involved in the management of the RGL portfolio, Edison Investment Research notes that LSPIM is backed by an experienced and growing team.
* '''Management risk:''' RGL is externally managed and is dependent on the ability of its asset manager to execute successfully on its strategy. Although Stephen Inglis, Derek McDonald and Simon Marriot, respectively CEO, managing director and investment director of the asset manager, LSPIM, are significantly involved in the management of the RGL portfolio, we note that LSPIM is backed by an experienced and growing team.


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==Actions==
To invest in Regional REIT, click [mailto:investor@regionalreit.com here].
To contact Regional REIT, click [mailto:investor@regionalreit.com here].
== Notes ==
<references />
[[Category:Thesis]]
[[Category:Equities]]
__INDEX__
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