19 April 2016

Custodian REIT: NAV and Intention to issue equity

Custodian REIT today reports its unaudited net asset value (“NAV”) as at 31 March 2016, highlights for the period from 1 January 2016 to 31 March 2016 (“the Period”) and its intention to issue equity.

Financial highlights

  • NAV per share of 101.5p (31 December 2015: 103.0p)
  • NAV total return1 for the year ended 31 March 2016 (“FY16”) of 6.2% (period ended 31 March 2015 (“FY15”): 7.0%)
  • FY16 ongoing charges ratio2 of 1.3% (FY15: 1.4%)
  • FY16 Q3 dividend paid on 31 March 2016 of 1.5875p per share (FY15 Q3: 1.25p per share)
  • Proposed FY16 Q4 dividend of 1.6625p per share (FY15 Q4: 1.5p per share)
  • Target FY16 dividend3 of 6.25p per share (FY15: 5.25p per share)
  • Heads of terms agreed for a £45.0m, 12 year, fixed rate loan
  • Net gearing4 of 19.2% loan-to-value (31 December 2015: 5.1% loan-to-value), rising to 20.6% on completion of committed pipeline of new acquisition opportunities
  • £13.7m of new equity raised during the Period at an average premium of 5.0% to adjusted5 NAV
  • Intention to issue equity at 104.9p per share implying a target yield6 on new shares of 6.05% for the year ending 31 March 2017

Portfolio highlights

  • Portfolio value of £318.2m (31 December 2015: £254.0m)
  • £66.7m invested in 11 acquisitions and on-going developments
  • £1.3m portfolio valuation uplift from successful asset management initiatives
  • Disposal of office for £1.35m, £0.15m ahead of 30 September 2015 valuation
  • £5.4m pipeline of committed funds

1 NAV movement plus dividends paid.
2 Expenses (excluding operating expenses of rental property) divided by average quarterly NAV.
3 Dividends paid and proposed.
4 Gross borrowings less unrestricted cash divided by portfolio valuation.
5 Premium adjusted to deduct dividends earned but not paid post ex-dividend date.
6 Target dividend for the year ending 31 March 2017 divided by proposed issue price of new shares.

Net asset value

The unaudited NAV of the Company at 31 March 2016 was £255.1 million, reflecting approximately 101.5 pence per share, a decrease of 1.5% since 31 December 2015:

The NAV attributable to the ordinary shares of the Company is calculated under International Financial Reporting Standards and incorporates the independent portfolio valuation as at 31 March 2016 and income for the Period, but does not include any provision for the proposed dividend for the Period, to be paid on 30 June 2016.

The Company invested £66.1 million in 11 acquisitions during the Period, its most significant quarter’s activity since IPO in 2014, acquiring:

  • Nine of the 11 properties in the ‘Target Portfolio’ described in the Company’s November 2015 prospectus (together “the Portfolio”) for £55.1 million on 4 January 2016. The Portfolio’s passing rent of £3.68 million reflected a net initial yield (“NIY”) of 6.32%, with an expected reversionary yield of 6.89%;
  • A retail warehouse in Banbury let to B&Q for £6.525 million with a NIY of 6.94%; and
  • A leisure park in Perth, comprising three units trading as Bannatyne Health Clubs, KFC and Frankie and Benny’s for £4.5 million, with a NIY of 8.17%.

These acquisitions incurred costs of £3.4 million reducing NAV by 1.4 pence per share, but increased the Company’s rent roll by 19.4% at an aggregate NIY of 6.5%, enhancing dividend cover while maintaining the quality of property and security of income in line with our investment strategy.

On 1 April 2016 the headline rate of SDLT for commercial property increased from 4% to 5%, with relief for smaller properties via a new SDLT-free band up to £0.15 million and a 2% band from £0.15 million to £0.25 million, replacing the previous flat rate. As a result, the increase in headline rate only impacts transactions above £1.05 million and then on a sliding scale as lot-size increases.

The Company’s focus on properties with lot-sizes up to £7.5 million has partially insulated it against the one-off impact these changes have had on valuations, with its average lot size of £2.9 million seeing a valuation decrease of 0.25%. To put this into context, the costs of acquiring a £3 million property have increased by 0.61% and a £10 million property by 0.85%, and valuations are expected to adjust accordingly across the property market this quarter.

Outside of recent SDLT changes, a 1.1% rise in vacancy following the determination of a tenant’s lease at expiry in Edinburgh resulted in a £1.0 million valuation decrease, which was more than offset by a £1.3 million uplift from asset management activities during the Period. The recently vacated office space in Edinburgh is being actively remarketed. Rental growth is in evidence in Edinburgh and marketing advice suggests a new letting could set an increased headline rent for the building. Proposals to refurbish the reception area should also have a positive impact on rental level and assist in attracting a new tenant.

Asset management

Successful asset management strategies including rent reviews, new lettings, lease extensions and the retention of tenants beyond their contractual break clauses have all helped to minimise the impact of the SDLT changes. Key asset management initiatives completed recently include:

  • Extending Pizza Hut UK Limited’s lease at Triangle Retail Park, Leicester with expiry moving from June 2018 to June 2033, subject to a tenant-only break option in June 2028, and rent increasing from £82,250 per annum to £104,512 per annum from June 2018.
  • Extending leases at the 40 St. David Street and Cardinal House offices in Leeds, occupied by Enact Direct Legal Solutions (the Company’s largest tenant by income representing 2.7% of the rent roll) by five years to expire in December 2023. Both leases have also been assigned to First Title Limited, Enact Direct Legal Solutions’ UK parent company, significantly strengthening the covenant.

Other completed initiatives include:

  • Letting the last vacant office suite in Lancaster House, Birmingham;
  • Extending the lease on the industrial unit let to Triumph Structures, Farnborough; and
  • Agreeing new lease terms on the vacant retail unit in Portsmouth.

The Company intends to maintain a weighted average unexpired lease term of over five years to the first lease break or lease expiry across the portfolio. Through successful asset management activities and acquiring long leases at Banbury and Perth, the expiry profile has improved with income expiring within five years falling from 53.5% at 4 January 2016 to 48.1% at 31 March 2016, as follows:


7 Date of acquisition of the Portfolio.

Property market

Commenting on the commercial property market, Richard Shepherd-Cross, Managing Director of Custodian Capital Limited (the Company’s external fund manager), said:

“The start of 2016 marked a watershed in recent attitudes to UK commercial property. In January, many mainstream listed property companies saw a dramatic fall in their share price, many property investment companies saw their shares fall to a discount to NAV and the open-ended property funds witnessed net outflows of capital after three years of net positive inflows.

“Reasons for this shift in attitude could include the uncertainty of ‘Brexit’ or the perceived end of a cycle, but questioning whether commercial property investment remains a valid choice or whether it’s time to call time on property as an asset class is too simplistic. Property is a diverse asset and its investment performance is driven by myriad different dynamics. Furthermore, it could be considered hasty to ignore a high yielding asset in a largely low return environment or to conform to a short-term change in sentiment when assessing an asset that performs over the long-term.

“I believe the key determinants of return and the sustainability of return in 2016 are likely to be income and income growth, both of which are driven by the occupational market rather than the investment market.

“In 2014 and particularly in 2015, excessive investment demand, both domestic and overseas, was focused on London, the South-East and the dominant regional cities. This imbalance of demand over supply resulted in price inflation and thus capital value growth. Capital growth is likely to be more muted in 2016 and in some market ‘hotspots’ we might witness a decline in values as investment demand weakens and significant redemptions from the open-ended funds lead to increased supply.

“Despite the investment market dominating the headlines, the real commercial property story of the last two years has been the return to health of the occupational market. In office and industrial markets, a lack of supply following seven years of minimal speculative development is pushing vacancy rates to all-time lows and driving rental growth. Low vacancy rates, which are also a feature of the retail warehouse sector, enhance cash flow from investment portfolios and support dividend cover. I expect rental growth to offer Custodian REIT the potential for dividend growth and sustainable capital growth over time.

“The occupational market story is particularly resonant in regional property. Market pricing has been more stable as it has not witnessed the excess demand pressure from the investment market and returns have been more closely linked to the occupational market performance. As a result we are witnessing rental growth and low vacancy rates across the Company’s portfolio.

“The market dynamics fit very well with Custodian REIT’s investment strategy and we anticipate there being further opportunities to purchase properties that will enhance returns to shareholders through rental growth and offer stable returns in an uncertain environment.”

Activity and pipeline

In the forthcoming quarter, the Company intends to continue its asset management activities and complete on the current acquisition pipeline, with the aim of deploying debt facilities to increase gearing towards the target level of 25%.

Commenting on pipeline, Richard Shepherd-Cross said:

“We have a strong committed pipeline including pre-let development funding projects totalling £3.4 million which, once complete, will improve the portfolio’s weighted average unexpired lease term, plus an acquisition opportunity in Chester of £2.0 million. Following the Period end we achieved practical completion of the development of a 63,000 sq ft warehouse unit in Cannock and the comprehensive refurbishment of the vacant unit at Bradbourne Drive, Milton Keynes, and completed the acquisition in Chester.

“The smaller lot-size, regional market has not yet seen the price inflation which has been a feature of London and large lot-sizes, so it is still possible to acquire properties with strong investment credentials. We continue to see opportunities consistent with our investment strategy and we are actively considering £25 million – £50 million of opportunities that maintain a threshold level of quality in building, location and tenant.

“We are keen to capitalise on the strength of the occupational market and are seeing a robust stream of opportunities which we expect to improve if redemptions from the open-ended funds lead to an increasing flow of sales.”

Intention to issue equity

In response to continued investor demand, a pipeline of attractive investment opportunities and the prevailing market conditions, the Board today announces that the Company is intending to raise additional equity capital through the issue of new ordinary shares (“the New Shares”) by way of a placing (“the Placing”). The Placing price of 104.9 pence at per New Share represents a premium of 5% to the ex-dividend unaudited NAV per share at 31 March 2016 of 101.5 pence. The Company’s existing Placing Programme set out in the Company’s November 2015 prospectus will remain in place until its expiry on 3 November 2016.

Qualified investors (as defined in section 86(7) of the Financial Services and Markets Act 2000 (as amended)) are invited to apply for New Shares by contacting Numis Securities Limited (“Numis”) on the contact details below. The decision to allot New Shares to any qualified investor shall be at the absolute discretion of the Company and Numis.

Reasons for the Placing and use of proceeds

Completion of the committed acquisition pipeline will increase loan-to-value to 20.6%, compared to target gearing of 25.0% loan-to-value, leaving limited headroom for further investment. The net proceeds of the Placing are expected to be used first to repay an element of the £26 million currently drawn under the Company’s revolving credit facility (“RCF”) at 31 March 2016. The remaining net proceeds are then expected to be used to acquire additional UK commercial real estate that can further diversify the portfolio and enhance income yield, such that the Placing is in Shareholders’ interests. Net proceeds are expected to be fully invested within three to six months after admission of the New Shares, depending on the amount of net proceeds of the Placing.

Expected timetable

Announcement of unaudited NAV as at 31 March 2016, Placing opens: 7.00 a.m. 19 April 2016
FY16 Q4 ex-dividend date: 5 May 2016
Latest time and date for receipt of commitments under the Placing: 11.00 a.m. 12 May 2016
Announcement of results of Placing: 7.00 a.m. 13 May 2016
Admission and dealings in New Shares on the London Stock Exchange’s Main Market: 8.00 a.m. 17 May 2016
Publication of final results: 7.00 a.m. 7 June 2016
FY16 Q4 dividend payment date: 30 June 2016

Financing

Equity

The Company issued 12.82 million new ordinary shares of 1 pence each in the capital of the Company during the Period (“the Shares”) raising £13.7 million (before costs and expenses). The Shares were issued at an average premium of 5.0% to the NAV per share at 31 December 2015, after adjusting this NAV to recognise the dividend of 1.5875 pence per share paid on 31 March 2016 to shareholders on the register at the close of business on 5 February 2016.

Debt

The Company operates a £35 million RCF with Lloyds Bank plc, which attracts interest of 2.45% above three month LIBOR with no commitment fee and expires on 13 November 2020. The Company also operates a £20 million term loan with Lloyds Bank plc (“the Term Loan”), which attracts interest of 1.95% above three month LIBOR and is repayable on 10 October 2019, and a £20 million term loan with Scottish Widows plc, which attracts interest fixed at 3.935% and is repayable on 14 August 2025.

Heads of Terms have been agreed for Scottish Widows plc to provide the Company with a new £45 million term loan facility (“the New Loan”), repayable 12 years from drawdown at a fixed rate of interest. The Company intends to use £20 million of proceeds from the New Loan to repay the Term Loan, with the remaining proceeds used to repay an element of the £26 million currently drawn under the RCF at 31 March 2016.

Portfolio analysis

The portfolio consists of 112 assets, with 228 tenancies and a NIY of 6.88%.

The portfolio is split between the main commercial property sectors, in line with the Company’s objective to maintain a suitably balanced investment portfolio, but with a relatively low exposure to office and a relatively high exposure to industrial and to alternative sectors, often referred to as ‘other’ in property market analysis, as demonstrated in the sector weightings below:


8 Includes car showrooms, petrol filling stations, children’s day nurseries, restaurants and hotels.

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 has proved to be an out-performer over the long-term and continues to be a target for acquisitions.

Office rents are growing strongly and supply is constrained by a lack of development and the extensive conversion of secondary offices to residential making returns very attractive. We were pleased to increase exposure to the office sector through the recent portfolio acquisition. However, the Company’s relatively low exposure to the office sector is a long-term strategic decision rather than a short-term comment on the state of the office market. We are conscious that obsolescence 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.

Similar to the office market, occupational demand is driving rental growth in the industrial sector and returns are positive. As industrial property is less exposed to obsolescence this sector remains a very good fit with the Company’s strategy.

Retail is split between high street and out-of-town retail (retail warehousing). Strong comparison retail pitches in dominant regional towns continue to show very low vacancy rates and offer stable long-term cash flow, with the opportunity for rental growth. Retail warehousing is witnessing close to record low vacancy rates as a restricted planning policy and lack of development combine with retailers’ requirements to offer large format stores, free parking and ‘click and collect’ to consumers.

The Company operates a geographically diversified portfolio across the UK, seeking to ensure that no one area represents the majority of the portfolio. The geographic analysis of the Company’s portfolio at 31 March 2016 is as follows:

For details of all properties in the portfolio please see www.custodianreit.com/property/portfolio.php.

Dividends

An interim dividend of 1.5875 pence per share for the quarter ended 31 December 2015 was paid on 31 March 2016. The Board expects to propose an interim dividend relating to the Period of 1.6625 pence per share to achieve the target dividend9 of 6.25 pence per share for the financial year ended 31 March 2016, which is expected to be fully covered by net rental income.

In the absence of unforeseen circumstances, the Board intends to pay further quarterly dividends to achieve a target dividend9 of 6.35 pence per share for the financial year ending 31 March 2017. The Company’s aim is to continue to increase dividends in a sustainable way, at a rate which is fully covered by net rental income and which does not inhibit the flexibility of its investment strategy.

9 This is a target only and not a profit forecast. There can be no assurance that the target can or will be met and it should not be taken as an indication of the Company’s expected or actual future results. Accordingly, shareholders or potential investors in the Company should not place any reliance on this target in deciding whether or not to invest in the Company or assume that the Company will make any distributions at all and should decide for themselves whether or not the target dividend yield is reasonable or achievable.

Important notice

This announcement does not constitute or form part of, and should not be construed as, any offer for sale or subscription of, or solicitation of any offer to buy or subscribe for, any shares in Custodian REIT plc or securities in any other entity, in any jurisdiction, including the United States, nor shall it, or any part of it, or the fact of its distribution, form the basis of, or be relied on in connection with, any contract or investment decision whatsoever, in any jurisdiction. This announcement does not constitute a recommendation regarding any securities. Neither the content of the Company’s website (or any other website) nor any website accessible by hyperlinks to the Company’s website (or any other website) is incorporated in, or forms part of, this announcement.

This announcement has been prepared by, and is the sole responsibility of, Custodian REIT Plc. Terms used and not defined in this announcement bear the meaning given to them in the Company’s November 2015 Prospectus.

Numis is acting only for Custodian REIT Plc in connection with the matters described in this announcement and is not acting for or advising any other person, or treating any other person as its client, in relation thereto and will not be responsible to anyone other than the Company for providing the regulatory protection afforded to clients of Numis or advice to any other person in relation to the matters contained herein.

The Company is not and will not be registered under the US Investment Company Act of 1940, as amended. The Ordinary Shares have not been, nor will they be, registered under the US Securities Act of 1933, as amended or with any securities regulatory authority of any state or other jurisdiction of the United States or under the applicable securities laws of any other Excluded Territory. Subject to certain exceptions, the Ordinary Shares may not be offered or sold in the United States or any Excluded Territory or to or for the account or benefit of any national, resident or citizen of any Excluded Territory, which includes any person located in the United States. Placings under the Placing Programme and the distribution of this announcement in other jurisdictions may be restricted by law and the persons into whose possession this announcement comes should inform themselves about, and observe any such restrictions.

This announcement includes “forward-looking statements”. All statements other than statements of historical facts included in this announcement, including, without limitation, those regarding the Company’s business strategy and plans are forward-looking statements.

Forward-looking statements are subject to risks and uncertainties and accordingly the Company’s actual future financial results and operational performance may differ materially from the results and performance expressed in, or implied by, the statements. These factors include but are not limited to those that are described in the Company’s November 2015 prospectus. Given these uncertainties, undue reliance should not be placed on such forward-looking statements.

These forward-looking statements speak only as at the date of this announcement. The Company expressly disclaims any obligation or undertaking to update or revise any forward-looking statements contained herein to reflect actual results or any change in the assumptions, conditions or circumstances on which any such statements are based unless required to do so by the Financial Services and Markets Act 2000, the Financial Services Act 2012, the Listing Rules, the Disclosure Rules and Transparency Rules or the Prospectus Rules of the Financial Conduct Authority or other applicable laws, regulations or rules.

Certain statements have been made with reference to forecast price changes, economic conditions and the current regulatory environment. Nothing in this announcement should be construed as a profit forecast. Past share price performance cannot be relied on as a guide to future performance.