17 Aug 2017

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REI – The way to play the ex-London property recovery

This post will be the first in a series detailing our existing ‘longer-term’ (anywhere between 3 months and a year) positions.

Disclosure: We have been long Real Estate Investors plc (RLE LN) since October 2013.

 

Investment Thesis

RLE is a property investment company based in the Midlands. 90% of the portfolio is in Birmingham, where the company has a compelling competitive advantage given the Charman, Paul Bassi, has a significant interest in local estate agency CP Bigwood and >30 years of auction experience in the area.

NAV of the portfolio is currently at c.45m or 60p per share. Therefore, the company trades at a discount to NAV of 0.8x. This is unwarranted given the company’s good history of asset recycling (recent asset sales were done at 20% premium to book value), >80% occupancy and progressive dividend policy. This is also a 27% discount to the (London dominated) sector average.

RLE typically acquires assets at a 10-20% initial rent yield at auction and will then perform a degree of asset management (renewals, renovations, administration). The company will either then sell the property let, often to large commercial property funds, or let the property themselves. Typically, the process of asset management can compress the rent yield on a property from upwards of 10% to as low as 8%, generating a strong uplift in NAV for RLE.

Figure 1 below demonstrates the key thesis behind owning RLE at this stage of the cycle. Prime rent yields (London) compressed considerably after the crisis (economic recovery, safe haven money flows, structural changes e.g. French tax rate). Secondary (ex-London) rent yields, however, have been slower to react – the spread between the two was at its widest in 2012 and has only compressed marginally (c.50bps) since. This is even more compelling given the evidence for regional recovery.

Figure 1. Prime vs Secondary Yields

Prime vs Secondary Yields

 

 

 

 

 

Near-term Catalysts

  • RLE completed 3 key disposals in H2 2013, struck at a 20% premium to book value. The company has stated its ambition to continue disposing of assets if it can achieve <8% rent yield at sale . Anecdotally, the influx of international property funds into the Midlands, in the search of ex-London yield, is driving deals into 6-7% territory, which is in-line with mid-cycle norms.
  • Birmingham office annual take-up has increased by 33% y/y which is a positive illustration of the recovery underway in this regional occupational market. We expect the shortage of supply to begin to drive rental growth in 2014/2015.
  • The company is aiming for £100m gross asset value by the end of Q1 ’14, given it now has access to cheaper financing from Insurance companies (dis-intermediation of Bank). Sees GAV at £200m by the end of 2014. This should drive a 30-50% NAV upgrade as unlet  and developing properties, which are unfinanceable, are asset managed.
  • Potential for a portfolio sale (e.g. £30-50m ‘high street’ property cluster) to a large instution, generating a massive upgrade to NAV overnight and crystallising valuations.

About the author

convexityPM

Over 5 years trading multi-asset portfolios and managing client money. Style proposition is detailed in 'Thesis' - broadly we aim to take positions in any market as long as a defined edge is evident and only then when very specific conditions present themselves (typically low risk, high reward but low probability outcomes). Previously, sell-side analyst & trader in both the credit and equity markets.

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