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Custodian Property Income REIT plc: Leasing momentum continues to drive income returns and support fully covered dividends
Custodian Property Income REIT plc (CREI)
8 February 2023
Custodian Property Income REIT plc
(“Custodian Property Income REIT” or “the Company”)
Leasing momentum continues to drive income returns and support fully covered dividends
Custodian Property Income REIT (LSE: CREI), which seeks to deliver a strong income return by investing in a diversified portfolio of smaller regional properties across the UK, today provides a trading update for the quarter ended 31 December 2022 (“Q3” or the “Quarter”).
Strong leasing activity continues to support rental growth and underpin fully covered dividends
£13.5m of disposals during the Quarter achieved at valuation, demonstrating the continued demand for small lot sized commercial property
Gearing remains low and in line with target, with significant borrowing headroom
Richard Shepherd-Cross, Managing Director of Custodian Capital Limited, said: “Our active asset management has enabled us to capture occupational demand, lease vacant space across all sectors and deliver rental growth which will support earnings and underpins the Company’s fully covered dividend. This strong recent leasing activity demonstrates the resilience of Custodian Property Income REIT’s well-diversified investment portfolio and the depth of the occupational market for space in high quality, well located and affordable assets such as ours.
“Despite recent market wide valuation decreases, Custodian Property Income REIT’s prudent approach to investment and the management of its balance sheet, with low gearing and a longer-term fixed rate debt profile, has left the Company well insulated from the negative impact of interest rate rises continuing in the short to medium-term.
“More broadly, despite investment market volatility during 2022 and the threat of an imminent recession, I believe the real estate market is in a much better place than it has been for the last 18 months. Rent collection levels remain very strong, the restrictions and impact of COVID-19 on tenants’ businesses are largely resolved and unlike in previous recessions we are not faced with an over-supply of real estate and rising vacancy rates at the outset.
“As a result, we remain confident that our ongoing intensive asset management of the portfolio, which still offers a number of wide-ranging opportunities to add value, will maintain cash flow and support consistent returns. Coupled with the strength of the Company’s balance sheet, this will continue to support our high income return strategy.”
Net asset value
The unaudited NAV of Custodian Property Income REIT at 31 December 2022 was £440.0m, reflecting approximately 99.8p per share, a decrease of 13.9p (-12.2%) since 30 September 2022:
The NAV attributable to the ordinary shares of the Company is calculated under International Financial Reporting Standards and incorporates the independent portfolio valuation at 31 December 2022 and net income for the Quarter. The movement in NAV reflects the payment of an interim dividend of 1.375p per share during the Quarter, but does not include any provision for the approved dividend of 1.375p per share for the Quarter to be paid on 28 February 2023.
Investment Manager’s commentary
UK property market
During the last six months Custodian Property Income REIT has demonstrated the strength of its strategy and the continued attractiveness to all sizes of occupiers of the assets in the Company’s portfolio, despite significant economic adversity. While our capital values are not immune from the effects of cost inflation and rising interest rates the Company’s income focused strategy and highly diversified portfolio of smaller regional properties has delivered robust earnings, supporting fully covered dividends and lower volatility in valuations than the wider market.
The broader UK property market saw valuations fall by 18% during the second half of 2022[7]. By contrast the Company’s smaller regional property strategy, which had not seen the pricing extremes of the post-COVID-19 period, experienced only a 15% decrease in like-for-like values over that six-month period. This contrast is even more marked for the industrial sector where during the Quarter the market recorded a 20% reduction in logistics values[8] compared to the Company’s industrial portfolio experiencing only an 11% decrease.
The lower volatility of the Company’s underlying property portfolio was mirrored in share price total return[9]. 2022 delivered negative total returns for nearly all listed property companies and REITs recorded aggregate -34% share price total returns for 2022 with companies ranging from just positive to -46%[10]. Custodian Property Income REIT delivered -2% share price total return during 2022 and we believe as confidence in real estate is restored in 2023 dividends, fully covered by earnings, will be recognised as the key element of total return.
In common with many market commentators, we believe that market values are stabilising, as the Bank of England makes increasingly clear statements about the trajectory of interest rates and gilt rates offer a more consistent comparator for investment returns and provide some certainty for lending banks.
Despite investment market volatility during 2022, in many ways the real estate market is in a much better place than it has been for the last 18 months. Rent collection levels are very strong, COVID-19 restrictions appear to be behind us and the impact of COVID-19 on tenants’ businesses is largely resolved. Despite the threat of an imminent recession, unlike in previous recessions we are not faced with an over-supply of real estate and rising vacancy rates at the outset.
Indeed, record low vacancy rates in the industrial sector are still driving rental growth. The economics of development now require rents on new developments to be higher than six months ago. To generate the necessary gross development value required to deliver new developments, higher investment yields and increased costs of labour and materials dictate that rents must also be higher, adding to upward rental growth pressure in the sector.
We still see rental growth potential in strong regional city centres for offices that are well-specified for post-pandemic working practices, with high levels of amenity, excellent environmental credentials, flexible lease terms and a high quality fit out – possibly fully fitted by the landlord. There is, however, a two-tier office market developing with buildings that cannot meet occupational trends seeing continued valuation falls and a very limited investor market.
We see continued growth in drive-through restaurant rents and have recently settled rent reviews ahead of ERV at two drive-throughs in York.
Across the whole portfolio, valuers’ estimates of rental value stand some 15% ahead of passing rent. While part of this reversion is due to vacancy, the balance is latent rental growth which will be unlocked at rent review and lease renewal.
During the Quarter, the Company agreed ten new leases securing £1.2m rent for a further 7.3 years and has continued to see good levels of occupier activity. Four new leases have already been signed since the Quarter end and there is a strong pipeline of asset management and refurbishment/redevelopment opportunities.
One of the strengths of a diversified and mature real estate portfolio is that even when market conditions do not favour acquisitions or disposals there are wide ranging investment opportunities in the standing portfolio. We have a 12-18 month capital investment pipeline of c.£28m across 23 projects, which is forecast to deliver superior investment properties, improved energy performance, enhanced rental cash flows and a positive impact on net asset value.
Asset management
The Investment Manager has remained focused on active asset management during the Quarter, completing the following new leases, with a weighted average unexpired term to first break or expiry (“WAULT”) of 7.3 years, bringing the portfolio total to 4.8 years:
During the Quarter the following rent reviews were settled with:
The positive impact of letting vacant space has increased EPRA occupancy to 89.9% (30 September 2022: 89.3%). Of the Company’s remaining vacant space 48% is subject to refurbishment or redevelopment, 8% was let post Quarter end and 8% is under offer for sale or lease.
Since the Quarter end the following initiatives have completed:
Fully covered dividend
The Company paid an interim dividend of 1.375p per share on 30 November 2022 relating to the quarter ended 30 September 2022. The Board has approved another interim dividend per share of 1.375p for the Quarter, fully covered by EPRA earnings, payable on 28 February 2023. The Board is targeting aggregate dividends per share[11] of at least 5.5p for the year ending 31 March 2023. The Board’s objective is to grow the dividend on a sustainable basis, at a rate which is fully covered by net rental income and does not inhibit the flexibility of the Company’s investment strategy.
Additional details on disposals
During the Quarter the Company made the following disposals:
Since the Quarter end the Company has sold a high street retail unit in Bury St Edmunds at auction for £0.54m, £0.14m (35%) ahead of valuation. The lease term had been recently increased by five years but with annual rent decreasing from £53k to £40k, and rents were not anticipated to recover in the short-medium term.
Borrowings
Custodian Property Income REIT operates the following agreed borrowing facilities, with £175m currently drawn of which 80% is at a fixed rate of interest. These facilities have no expiries until September 2024 and a weighted average term of 6.1 years:
Variable rate borrowing
Fixed rate borrowing
The Company’s weighted average cost of its drawn debt facilities is 3.7%.
Each facility has a discrete security pool, comprising a number of individual properties, over which the relevant lender has security and covenants:
Portfolio analysis
At 31 December 2022 the property portfolio comprised 162 assets with a net initial yield[12] (“NIY”) of 6.5% (30 September 2022: 5.9%). The portfolio is split between the main commercial property sectors, in line with the Company’s objective to maintain a suitably balanced investment portfolio. Sector weightings are shown below:
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