REGIONAL REIT
Key Facts: Buy RGL at 30.9pps (22/09/23). 515.74m shares in issue. MarCap £158.6m
Discount to EPRA NTA 53.8%.
a/ EPRA NTA per share 66.9pps (£344.9m)
b/ IFRS NAV of 72.5pps (£402.9m).
c/ EPRA Net Disposal Value (NDV) of 77.6pps (£400.2m)
Why are there 3 NAVs? - The difference between EPRA and IFRS is that EPRA takes into consideration what’s happened to the properties i.e. revaluation, dividends paid, gains or losses on disposal. So EPRA is the “true” measure whereas IFRS shows the static state of “if nothing had changed”. EPRA NDV represents the shareholders' value in a disposal scenario.
To say Regional REIT has fallen dramatically is not an exageration. Down by two thirds over the past 18 months. Worth half of its Covid lows. Let me repeat that. When offices were closed, and the pandemic had masked us all in its grip, this REIT was worth DOUBLE what you can buy it for today
(i.e. when NO offices are closed and 84% of businesses now have their people in offices at least some of the time).
Does that not strike you as lunacy?
So why the poor performance?
Debt:
REIT has debt its true. Quite a lot in fact. The arguments given on bulletin boards have been the debt is “out of control” and “spiralling”, but let’s look at the facts:
The debt is fixed - partly through fixed terms or bonds and partly through derivatives that compensate for any interest rate rises (Sonia - you little minx)
The debt is due. £50m in 1 year. Quite a bit more in 4 years time.
The debt LTV (or loan to value) is high. This is the real problem. RGL have a convenant to not exceed 60%. Because valuations have fallen, the relation of “V” in LTV has dropped so the ratio has increased….. even as the debt is also dropping.
Profitability:
RGL is profitable. Always has been and is forecast to continue to be. It has diverse tenants - diverse by geography, industry sector, with no particular concentration or dependency.
Ah but what about the Voids. Yes that’s true. The voids (empty properties) are quite high. If it could sort out its voids then its profits would grow up to 75%, like this. I’m assuming (conservatively) property costs pro rata go up although they pass through many costs.
In this scenario you’ll notice finance expenses are static. But what if RGL sold off some of its property?
The funny thing is it makes not much difference. Rental income drops but (again) property costs logically reduce too. Importantly finance costs drop too. (I’ll show you the balance sheet later). People on Bulletin Boards have frothed at the doomsday scenario that disposals would cause yields to drop.
These numbers assume NO REDUCTION OF VOIDS. But logically you’d dispose of your least populated properties…. wouldn’t you?
It’s true I’m assuming disposal at book so the impact if it’s less than book impacts the Finance Expense. Disposing at 10% less than book impacts the number by less than £200k
Where’s the doomsday scenario in that? Show me the numbers to arrive at doomsday because I’ve run model after model and I can’t achieve it.
Well that’s not true. I can. The number rely on a drop of 19% (from June 2023’s numbers) seems to be enough:
Scenario 4 - If RGL disposes of £30m of property at a 19% discount to NAV, but its ENTIRE portfolio also drops by 19%. What is the resultant LTV?
ANSWER: 60.09% - a convenant breach
But even then, it’s also dependent on RGL only being able to dispose of a small amount of property. If you double the disposals - you then need to double the discount to breach that covenant.
i.e. Scenario 5 - If RGL disposes of £60m of property at a 19% discount to NAV, what market drop would lead to a LTV >60%
ANSWER: A 40% drop from here.
In the past periods the average disposals were around £80m.
What happens to the balance sheet if disposals are made at book value?
I ran 2 scenarios for 10% of the portfolio and 20%.
Why do I believe offices don’t have much further to fall?
1/ Replacement cost:
RGL’s assets have a NAV value of £116.91 a square foot. Or £1,258 a square metre.
When we talk about a disposal at 77.6p a share that’s based on a value well behind what offices cost to build. In fact if you assume that a disposal at A-grade build cost of Glasgow (52.3% of properties by valuation are in the SE, Midlands or NW so again - conservative) then you arrive at a RGL share price of 161.6p.
On that basis, RGL is on a discount of over 80.8%
2/ Rebound
There’s a key paragraph from the H1 report I think investors have missed - or not understood the implications. Research by LSH:
“Two regions that experienced robust levels of investment in Q2 2023 were the West Midlands and the South East. Total investment in the West Midlands reached £0.6 billion, 10.8% above the five-year quarterly average - the strongest regional performance relative to trend. Data from LSH shows that £0.5 billion was invested in the South East. Other regional markets that performed well relative to trend include Scotland and the North West of England.”
Combine that information with the ratio of properties (see below) and 38.6% of properties are in areas with above average levels of activity. And 30.1% more slightly above average. That’s over 2/3 of properties (by value)! Does that sound like Doomsday?
Meanwhile in the past 18 months, according to the ONS the proportion of businesses which have their people in offices at least some of the time has grown from 74% to 84%. That’s 15% more people working in (presumably) 15% more offices.
3/ Macro:
Interest rates are on hold - and dovish signals are coming from the BoE. In fact LSH conclude about offices in their report:
“…greater clarity could be felt by investors as the (Q3) quarter progresses and this may be the foundation for a recovery in activity in Q4, and more definitely in 2024.”
Moreover Jamie Constable argues that we are now at peak rates, and in fact presents a bullish picture for 2024 as incomes rise as real rates progressively exceed zero. You can watch his thesis here:
Future Optimism
What will the numbers look like when there is a rebound?
The answer is that the LTV rapidly comes under control. This is with ZERO DISPOSALS. Just what the balance sheet does when the EPRA NAV increases by 5% - 15% from the June 23 valuations. (the NAV would need to increase 33% to return to its Pandemic levels so is even 15% conservative?)
Or combining 20% disposals at book plus a subsequent 15% uplift takes the LTV to just 33.4%
When voids improve operational profitability rises by up to 75%.
If/when office values reflect their current replacement cost - the NAV more than doubles. Repeating the above scenario (20% disposed + 15%+100% uplifts) you now have a LTV of under 17%
At no point have I discussed the 1.25x fully covered dividend which at 1.2p a quarter is 4.8p a year of 15.5% yield to the current market price. Oops, I just did.
This has been reduced from 1.65p a quarter or a 21.4% yield. Not impossible to get back to that yield or better. My numbers demonstrate that.
Conclusion:
So to conclude while there’s a theoretical doomsday scenario reliant on a further 19%-40% drop in property values so where the £1258/sq.m falls to £755 a sq.m, where it’s 70% or more below the £2600++ Sq.m build cost. Does that seem realistic? Or if it happens, will it remain there? I just don’t buy it. The numbers indicate RGL is patently oversold at this point.
Debt cliff edge? Not really. There’s a £50m bond due next August which could either be refinanced, paid out of cash (there was £26m unrestricted cash as at 30/06, operational cash flow is £30m+ plus cash from disposals). Refinancing the £50m bond at 9.5%/year would cost £2.5m a year more. The rest of the debt is 4 years out. I’ve shown how it can be substantially paid down if needed, or refinanced, particularly as we now appear at peak rates. Remember debt is entirely normal for a REIT. In fact debt is the flywheel that generates the bumper returns which RGL is famous for.
For these reasons I consider RGL a strong buy.
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As with all my posts, this is not investment advice. It is written for my benefit, and to set out my investment rationale. I state facts and source them where possible. I also use words like “infer” and “think” which means it’s a reasoned opinion based on facts I’ve found. Investment requires filling in the gaps with inferences and thinking about the facts to form forecasts. I hope you enjoy what I write and find it useful in forming your own investment rationale.
Not a fan of the dilution