Custodian REIT (LSE: CREI), the UK commercial real estate investment company, today reports its final results for the year ended 31 March 2018.
Financial highlights and performance summary
- NAV per share total return1 of 9.6% (2017: 8.5%)
- EPRA2 earnings per share3 of 6.9p (2017: 6.6p), basic and diluted earnings per share of 8.9p(2017: 8.1p)
- Portfolio value of £528.9m (2017: £418.5m4)
- Profit after tax up 34% to £32.4m (2017: £24.2m)
- £54.7m5 of new equity raised at average premium of 11.1% to dividend adjusted NAV
- 2019 target dividend per share increased to 6.55p (2018: 6.45p)
- £106.3m6 invested in 20 acquisitions, one ongoing pre-let development and one significant refurbishment
- £8.8m valuation uplift from successful asset management initiatives, £5.7m net valuation increase7
- £1.6m profit on disposal of five properties for an aggregate consideration of £11.3m
1. Net Asset Value (“NAV”) movement including dividends paid and approved relating to the year on shares in issue at 31 March 2017.
2. The European Public Real Estate Association (“EPRA”).
3. Profit after tax excluding net gain on investment property divided by weighted average number of shares in issue.
4. Restated to reclassify the value of deferred lease incentives from receivables to investment property.
5. Before costs and expenses of £0.8m.
6. Before acquisition costs of £6.2m.
7. Comprising £8.8m of valuation uplift from successful asset management initiatives plus £3.1m of other valuation increases, less £6.2m of acquisition costs.
|
|
2018 |
2017 |
change |
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Return |
|
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|
|
|
NAV per share total return |
9.6% |
8.5% |
+1.1% |
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|
Share price total return8 |
6.7% |
10.3% |
-3.6% |
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|
Dividend cover9 |
105.5% |
101.0% |
+4.5% |
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|
|
|
|
|
|
Dividends per share10 (p) |
6.45 |
6.35 |
+1.6% |
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Capital values |
|
|
|
|
|
NAV (£m) |
415.2 |
351.9 |
+18.0% |
|
|
NAV per share (p) |
107.3 |
103.8 |
+3.4% |
|
|
Share price (p) |
113.0 |
112.0 |
+0.9% |
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|
Portfolio value (£m) |
528.9 |
418.511 |
+26.4% |
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|
Market capitalisation (£m) |
437.1 |
379.7 |
+15.1% |
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|
|
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|
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Premium to NAV per share |
5.3% |
7.9% |
-2.6% |
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Net gearing12 |
21.0% |
14.4% |
+6.6% |
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Costs |
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Ongoing charges ratio13 (“OCR”) |
1.37% |
1.61% |
-0.24% |
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OCR excluding direct property expenses14 |
1.15% |
1.20% |
-0.05% |
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EPRA performance measures |
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EPRA EPS (p) |
6.9 |
6.6 |
+4.5% |
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|
EPRA NAV per share (p) |
107.3 |
103.8 |
+3.4% |
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|
EPRA net initial yield (“NIY”) |
6.1% |
6.3% |
-0.2% |
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EPRA 'topped up' NIY |
6.5% |
6.7% |
-0.2% |
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EPRA vacancy rate |
3.5% |
1.4% |
+2.1% |
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EPRA cost ratio (including direct vacancy costs) |
15.3% |
18.0% |
-2.7% |
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EPRA cost ratio (excluding direct vacancy costs) |
14.6% |
16.1% |
-1.5% |
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8. Share price movement including dividends paid and approved for the year.
9. Profit after tax, excluding net gain on investment property, divided by dividends paid and approved for the year.
10. Dividends paid and approved for the year.
11. Restated to reclassify the value of deferred lease incentives from receivables to investment property.
12. Gross borrowings less unrestricted cash, divided by portfolio value.
13. Expenses (excluding operating expenses of rental property rechargeable to tenants) divided by average quarterly NAV.
14. Expenses (excluding operating expenses of rental property) divided by average quarterly NAV.
Alternative performance measures, including EPRA Best Practice Recommendations, are among the key performance indicators used by the Board to assess the Company's performance. EPRA performance measures have been disclosed to facilitate comparison with the Company's peers through consistent reporting of key performance measures. The Company is a FTSE EPRA/NAREIT index series constituent.
Commenting on the final results, David Hunter, Chairman of Custodian REIT, said:
“I am pleased to report that Custodian REIT has continued to deliver strong shareholder returns with NAV per share total return of 9.6% (2017: 8.5%) for the year. We invested a total of £106.3m on the completion of 20 acquisitions, one ongoing pre-let development and one significant refurbishment, funded principally by £54.7m raised from the issue of new shares and £50.0m of new term debt.
“We believe a well-defined investment strategy that offers secure income and focuses on long-term goals and deliverable targets will protect shareholders from market volatility.
“The strength of the occupational market represents an exciting opportunity and rental growth at lease renewal and rent review remains robust. The Company met its target of paying an annual dividend per share for the year of 6.45p (2017: 6.35p, 2016: 6.25p), 105.5% covered by net recurring income, and we expect proactive asset management that secures rental growth will continue to drive performance in the portfolio. We are confident we can maintain occupancy levels, which in turn will sustain our policy of paying a growing and fully-covered dividend to shareholders.”
Chairman's statement
I am pleased to report that Custodian REIT has continued to deliver strong shareholder returns with NAV per share total return of 9.6% (2017: 8.5%) for the year ended 31 March 2018. During the year we invested a total of £106.3m on the completion of 20 acquisitions, one ongoing pre-let development and one significant refurbishment, funded principally by £54.7m raised from the issue of new shares and £50.0m of new term debt. Increasing the scale of the Company and a continued focus on controlling costs has reduced the ongoing charges ratio (excluding direct property expenses) from 1.20% to 1.15%. We plan to achieve continued growth to realise the furthereconomies of scale offered by the Company's relatively fixed cost base and the reduced rate ofInvestment Manager fees from 1 June 2017, while adhering to the Company's investment policy and maintaining the quality of both properties and income.
The Company pays one of the highest fully covered dividends amongst its peer group of listed property investment companies15. During a period of further growth we have sought to minimise the impact of 'cash drag' following the issue of new shares by taking advantage of the flexibility offered by the Company's £35.0m revolving credit facility (“RCF”). I am delighted that proactive asset management of the portfolio to secure rental growth, coupled with the flexibility of the RCF and prompt deployment of cash as it has been raised through equity issuance, has allowed us to increase the target dividend16 for the year ending 31 March 2019 by 1.6% to 6.55p per share.
Through 2017 and into the first quarter of 2018 the market has been characterised by a very restricted supply of investment opportunities and a significant level of demand from a range of investors. Market demand has polarised, moving away from high street retail and focusing on industrial/logistics assets and properties let on long leases, particularly those with rents indexed to inflation. We believe the market is over-pricing some assets and we have taken a cautious approach to acquisitions. Custodian REIT has stuck firmly to its investment strategy making it more difficult, but not impossible, to deploy our available resources into the right property assets. Despite our success in investing more than £100m during the year, these market conditions have restricted our ability to satisfy demand for new equity issuance which in turn has seen the Company's shares trade at a premium well ahead of most of our peers. Current market dynamics look likely to persist and maintain the status quo for the rest of the year.
Custodian REIT remains focused on good quality regional property that might be considered too small for institutional investors. The Company continues to maintain a diverse portfolio strategy, allowing enough flexibility to be contracyclical where appropriate but always with a strong focus on acquiring assets that support the dividend policy of the Company. Furthermore, we believe a well-defined investment strategy that offers secure income and focuses on long-term goals and deliverable targets will protect shareholders from market volatility.
Net asset value
The NAV of the Company at 31 March 2018 was £415.2m, reflecting approximately 107.3p per share, an increase of 3.4% since 31 March 2017:
|
|
Pence per share |
£m |
|
|
|
|
|
NAV at 31 March 2017 |
103.8 |
351.9 |
|
Issue of equity in the year (net of costs) |
1.0 |
53.9 |
|
|
104.8 |
405.8 |
|
|
|
|
|
Valuation movements relating to: |
|
|
|
– Asset management activity |
2.3 |
8.8 |
|
– Other valuation movements |
0.8 |
3.1 |
|
Gross valuation increase |
3.1 |
11.9 |
|
|
|
|
|
Impact of acquisition costs |
(1.6) |
(6.2) |
|
Net valuation increase |
1.5 |
5.7 |
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|
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Profit on disposal of investment property |
0.4 |
1.6 |
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Net gain on investment property |
1.9 |
7.3 |
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Revenue |
9.0 |
34.8 |
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Expenses and net finance costs |
(2.5) |
(9.7) |
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Dividends paid17 |
(5.9) |
(23.0) |
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NAV at 31 March 2018 |
107.3 |
415.2 |
17. Dividends totalling 6.425p per share (1.5875p relating to the prior year and 4.8375p relating to the year) were paid on shares in issue throughout the year. Dividends paid on shares in issue at the year end averaged 5.9p per share due to new shares being issued after the first ex-dividend date.
The Company delivered NAV per share total return of 9.6% for the year, which was another period of significant new investment where the initial costs (primarily stamp duty) of investing £106.3m in 20 property acquisitions, one pre-let development and one significant refurbishment diluted NAV per share total return by circa 1.6p, largely offset by raising £53.9m of new equity (net of costs) at an average 11.1% premium to dividend adjusted NAV, which added 1.5p per share18 and fully coveredthe cost of raising and deploying the proceeds.
In addition to acquisitions, activity during the year also focused on pro-active asset management, which generated an £8.8m valuation uplift. We intend to continue our asset management activities and complete the current acquisition pipeline where we have identified compelling propositions, with the deployment of existing debt facilities expected to increase net gearing towards our target level of 25% loan-to-value (“LTV”).
18. 1.0p per share through new issuance at a premium to NAV plus 0.5p per share notional dividend saving due to new shares being issued after the year's first ex-dividend date.
Share price
Consistent demand for the Company's shares has led to its share price showing a relatively stable premium to NAV through the year.
This share price performance has been combined with a steadily increasing level of daily liquidity which now rates Custodian REIT as the second highest in its peer group in terms of volume of shares traded daily as a percentage of issued share capital19. This liquidity has done much to reduce volatility so the few instances of short-term share price volatility have quickly stabilised.
The Company enjoys the support of a wide range of shareholders with the majority classified as private client or discretionary wealth management investors. The Company's investment and dividend strategy is very well suited to investors looking for a close proxy to direct real estate but in a managed and liquid structure. The nature of shareholders has, in turn, helped to reduce volatility as they are typically long-term holders looking for stable dividend-driven returns.
19. Source: Numis Securities Limited.
Placing of new ordinary shares
The Company raised £54.7m of new equity during the year, placing 47.8m new shares at an average 11.1% (2017: 5.1%) premium to dividend adjusted NAV via an ongoing programme of tap issuance.
Borrowings
As at 31 March 2018 net gearing equated to 21.0% LTV. The Board's strategy is to:
- Increase debt facilities in line with portfolio growth, targeting net gearing of 25% LTV;
- Facilitate expansion of the portfolio to take advantage of expected rental growth; and
- Reduce shareholders' exposure to risk by:
Taking advantage of low interest rates to secure long-term, fixed rate borrowing; and
Managing the weighted average maturity (“WAM”) of the Company's debt facilities.
To achieve these objectives, on 5 April 2017, the Company and Aviva Investors Real Estate Finance (“Aviva”) entered into an agreement for Aviva to provide the Company with a new 15 year £50m term loan facility, comprising two tranches of £35m (“Tranche 1”) and £15m (“Tranche 2”) respectively. The Company drew down Tranche 1 on 6 April 2017, with a fixed rate of interest of 3.02% per annum, and drew down Tranche 2 on 3 November 2017 with a fixed rate of interest of 3.26% per annum.
The weighted average cost of the Company's agreed debt facilities at 31 March 2018 was 3.1% (2017: 3.1%) with a WAM of 9.1 years (2017: 10.1 years) and 77% (2017: 77%) of the Company's agreed debt facilities now at a fixed rate of interest. This removes significant interest rate risk from the Company and provides shareholders with a wide, beneficial margin between the fixed cost of debt and income returns from the portfolio.
Investment Manager
Custodian Capital Limited (“the Investment Manager”) was appointed at IPO under an investment management agreement (“IMA”) to provide property management and administrative services to the Company. The performance of the Investment Manager is reviewed each year by the Management Engagement Committee (“MEC”).
The Board is pleased with the performance of the Investment Manager, particularly the timely deployment of new monies on high quality assets, securing the earnings required to fully cover the target dividend, and the asset management successes.
On 1 June 2017, the Investment Manager was appointed for a further three years and fees payable to the Investment Manager under the IMA were amended to include:
- A step down in the property management fee from 0.75% to 0.65% of NAV applied to NAV in excess of £500m; and
- A step down in the administrative fee from 0.125% to 0.08% of NAV applied to NAV between £200m and £500m and a further step down to 0.05% of NAV applied to NAV in excess of £500m.
These amendments to the IMA secured an immediate reduction in the administrative fee rate, increasing cover on target dividends in the current and future years. Further growth in NAV, particularly above £500m, will further reduce the Company's ongoing charges ratio and increase dividend capacity.
WAULT
The Investment Manager's report sets out in detail a proposed change to the Company's investment policy regarding weighted average unexpired lease term to the earlier of first break or expiry (“WAULT”).
With the natural passage of time and the growth in size of the portfolio, as well as the general market overpricing of many longer lease assets, the target of maintaining a portfolio WAULT of more than five years is now inappropriate. It is proposed that this be changed to a more realistic objective to minimise rental voids and enhance the WAULT of the portfolio by managing lease expiries and targeting property acquisitions which will in aggregate be accretive to WAULT at the point of acquisition, on a rolling 12-month basis. The Board fully supports this change which will provide the Investment Manager with additional flexibility when looking for the best value properties to add to the portfolio.
Dividends
Income is a major component of total return. The Company paid aggregate dividends of 6.425p pershare during the year (totalling £23.0m), comprising the fourth interim dividend of 1.5875p per sharerelating to the year ended 31 March 2017 and three interim dividends of 1.6125p per share relating to the year ended 31 March 2018.
The Company paid an interim dividend of 1.6125p per share for the quarter ended 31 March 2018on 31 May 2018, meeting the Company's target of paying an annual dividend per share relating tothe year of 6.45p (2017: 6.35p, 2016: 6.25p), totalling £23.8m. Dividends relating to the year are 105.5% covered by net recurring income of £25.2m.
In the absence of unforeseen circumstances, the Board intends to pay quarterly interim dividends to achieve a target dividend of 6.55p per share for the year ending 31 March 2019. The Board's objective is to grow the dividend on a sustainable basis at a rate which is fully covered by projected net rental income and does not inhibit the flexibility of the Company's investment strategy.
Outlook
Notwithstanding our cautious approach to investment in the current market we believe that value can still be found with a disciplined approach to deployment with the strength of the occupational market representing an exciting opportunity which is discussed more fully in the Investment Manager's report. Rental growth at lease renewal and rent review remains robust. We expect proactive asset management and rental growth will continue to drive performance in the portfolio and are confident we can maintain occupancy levels, which in turn will sustain our policy of paying a growing and fully-covered dividend to shareholders.
David Hunter
Independent Chairman
4 June 2018
Investment Manager's report
The UK property market
Our review of the UK property market shows demand is outstripping supply in almost all sectors save for secondary retail. In November 2017 Property Week reported that allocations to commercial property now exceed 10% in global institutional portfolios, up from 8.9% in 2013. While a small percentage increase, the absolute impact has been significant resulting in competition for acquisitions as most participants in the commercial property market are targeting net investment across their portfolios. Is this a positive endorsement of the UK property investment market or is it looking like a late cycle bubble?
Last year I commented as follows: “We are not unduly concerned by this risk. The equivalent yield20 of the portfolio has been constant at c. 6.75% since 2014, although the NIY of the portfolio has hardened to reflect rental growth. This suggests that capital growth has been driven by the prospect of rental growth and not by underlying yield compression, lessening the risk of a reversal of gains made in the near future.”
A year on we have witnessed some equivalent yield compression in our valuations, principally driven by market pricing for industrial and logistics assets, which make up 39% of the portfolio, but we have also seen softening in pricing for high street retail which makes up only 14% of the portfolio. The net result has been an increase in the valuation of the portfolio, which we still believe is robust, showing a NIY of 6.6%. Furthermore, the aggregate NIY of the £103.8m of property acquisitions during the year was 6.7% which compares favourably to Lambert Smith Hampton's recently reported all property transaction yield of 5.67% for Q1 2018. This demonstrates that it is still possible to find properties that support Custodian REIT's attractive, fully covered dividend policy, but it is safe to say it is somewhat harder than 12 months ago. While we are not concernedthat the Custodian REIT portfolio is in a late cycle bubble, we are not immune from the market.
The first point to note is that the property market is very different: In 2007/2008 we were at the tail end of a debt driven, development boom which had left us with an over-supply of vacant property; we were at the end of rental growth cycle; we had debt fueled investment demand; interest rates were 5% and we were on the brink of a global banking collapse.
Current market conditions are somewhat different. We have had very low levels of development for 10 years and still there is very limited banking support for speculative development, leaving us with low levels of modern vacant real estate; rental growth may have peaked or even be declining in central London but in regional markets it is a different picture. Industrial and office rents have been growing since 2016 and while the rate of growth may be slowing there remain a large number of regional assets with latent rental growth. Investment demand is principally driven by equity rather than debt, although the low cost of finance is enhancing demand; interest rates are 0.5% and while we believe the Bank of England wishes to raise rates we envisage a medium term low rate environment, notwithstanding some small increases; and while we do not fear a banking crisis, we have the uncertainty of leaving the EU next year instead. The jury may be out on the outcome for UK plc of leaving the EU but we are hopeful that the impact on UK commercial property investment might be less than for those invested in assets directly linked to financial markets. Perhaps the current allocations to UK property support this view.
So even though the market backdrop is very different to 2007/2008, some investor activity has some of the hallmarks of a late cycle bubble. There seems to be a core of investors intent on deploying capital into the UK property market at any cost and some pricing reflects this. The hope of any market facing a bursting bubble is for a soft landing. We feel confident that the current occupational market dynamics and the low return environment will secure a soft landing for commercial property if one is needed.
20. The weighted average between the NIY and reversionary yield.
Occupational market
Strength in occupational markets has supported much of our asset management activities throughout the year. We have settled 17 rent reviews showing increases ranging from 2% to 87% with an 18% average adding £0.5m to the Company's rent roll. While much of the growth has come from the industrial sector, with 12 rent reviews, there has also been growth in other sectors with three retail rental uplifts and two alternative assets.
There remain a number of factors that should lead to a continuing period of rental growth:
- 2008-2016 saw rental levels in many regional markets fall in nominal terms against a background of annual economic inflation averaging c. 3% per annum, leading to like-for-like rental declines of 20-25%. As a result rents are now growing from a low and affordable base in real terms.
- Many regional markets are witnessing rental levels which remain below the threshold necessary to bring forward new development. This is a function of the fall in real rental levels against inflation in construction and labour costs. It would appear that there is a latent pool of rental growth on which the market must deliver before we see supply reach equilibrium with demand, thus maintaining pressure on rents to grow.
- Many tenant negotiations remain finely balanced, with tenants keenly aware of their value to landlords. However tenants are accepting of rental growth, which they may have avoided for as much as 10 years in many instances, which combined with limited supply of alternative premises, should continue to deliver rental growth albeit at a lessening rate.
In addition, 13% of the Company's rent roll benefits from fixed or indexed rental uplifts, althoughthere is increasingly strong evidence of open market rental growth matching or exceeding indexation.
However we have seen some weakness in secondary retail locations and expect to experience one or two rental reductions at lease expiry. Some tenants have taken matters into their own hands to bring about early rental reductions with the aggressive use of company voluntary arrangements (“CVAs”) to step away from their lease obligations or to reduce rents. Happily we have been largely unaffected by this. We have no exposure to House of Fraser or New Look and the lease over our restaurant let to Prezzo was assigned in advance of its CVA so we were unaffected, but Carpetright's CVA has resulted in a 25% reduction in rent at our Grantham store (a £25k drop in rent representing 0.07% of the Company's rent roll). This is perhaps where Custodian REIT has the greatest protection against the impact of CVAs or other tenant failure, as the Company's largest tenant represents only 3.2% of the total rent roll and with 201 tenants any instance of tenant default will have only a muted impact on the Company.
Investment objective
The Company's key objective is to provide shareholders with an attractive level of income by maintaining the high level of dividend, fully covered by earnings, with a conservative level of net gearing. We are delighted to have continued to achieve this, with earnings providing 105.5% cover of the approved total dividend relating to the year of 6.45p per share, with a net gearing ratio of 21.0% at the year end. As a result of the fund's growth and consequential reduction in OCR the Board has increased the target dividend for the next financial year to 6.55p per share.
We continue to pursue a pipeline of new investment opportunities with the aim of deploying the Company's undrawn debt facilities up to the conservative net gearing target of 25% LTV. At the current cost of debt, we believe this strategy can improve dividend cover as net gearing increases towards the target level.
We remain committed to a strategy principally focused on sub £10m lot size regional property. Weexpect to see continuing strong asset management performance as we secure rental increases and extend contractual income.
Portfolio balance
The portfolio is split between the main commercial property sectors, in line with the Company's objective to maintain a suitably balanced investment portfolio, with a relatively low exposure to office and a relatively high exposure to industrial, retail warehouse and alternative sectors, often referred to as 'other' in property market analysis. The current sector weightings are:
|
Sector |
Valuation 31 March 2018 £m |
Valuation 31 March 2017 £m |
Gross valuation increase21 £m |
Net valuation movement £m |
Weighting by income 31 March 2018 |
Weighting by income 31 March 2017 |
|
|
|
|
|
|
|
|
|
Industrial |
209.8 |
188.4 |
11.4 |
10.6 |
39% |
45% |
|
Retail warehouse |
107.5 |
48.8 |
1.0 |
(2.4) |
20% |
11% |
|
Other22 |
80.4 |
56.7 |
0.7 |
(0.7) |
15% |
13% |
|
Retail |
75.3 |
72.2 |
(2.8) |
(3.4) |
14% |
17% |
|
Office |
55.9 |
52.4 |
1.6 |
1.6 |
12% |
14% |
|
|
|
|
|
|
|
|
|
Total |
528.9 |
418.5 |
11.9 |
5.7 |
100% |
100% |
21. Before the impact of £6.2m acquisition costs.
22. Includes car showrooms, petrol filling stations, children's day nurseries, restaurants, health and fitness units, hotels and healthcare centres.
Industrial property is a very good fit with the Company's strategy where it is possible to acquire modern, 'fit-for-purpose' buildings with high residual values (ie the vacant possession value is closer to the investment value than in other sectors) and where the real estate is less exposed to obsolescence. £5.9m of the £11.4m gross valuation increase in the industrial sector was driven by asset management initiatives, with occupational demand driving rental growth and generating positive returns.
There is continued weakness in secondary high street retail locations, with rental levels still under pressure and a very real threat of vacancy. However, the high street is a polarised sector where many locations continue to be in demand by retailers. We will continue to rebalance the portfolio to focus on strong retail locations while working on an orderly disposal of those assets we believe are ex-growth. The current well-publicised crop of CVAs has the potential to increase vacancy levels in our retail warehousing portfolio, but set against a backdrop of very low vacancy rates in this sector we do not feel unduly exposed to long-term void risk.
While deemed to be outside the core sectors of office, retail and industrial the 'other' sector offers diversification of income without adding to portfolio risk, containing assets considered mainstream but which typically have not been owned by institutional investors. The 'other' sector continues to be a target for acquisitions.
Office rents in regional markets are growing and supply remains constrained by a lack of development and the extensive conversion of secondary offices to residential making returns very attractive. However, we are conscious that obsolescence and lease incentives can be a real cost of office ownership, which can hit cash flow and be at odds with the Company's relatively high target dividend, so while we are experiencing rental growth in our office portfolio, we remain a cautious investor.
For details of all properties in the portfolio please see www.custodianreit.com/property/portfolio.