Make a juicy income from commercial property

Regional Reit’s commercial property assets should provide investors with a sustainable yield, says David Stevenson.


Regional Reit's commercial property assets should provide investors with a sustainable yield, says David Stevenson.

Now that interest-rate rises in the US and the UK are looking less likely, we find ourselves in a good environment for well-managed income-producing assets.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

It's against this backdrop that I want to discuss the real-estate investment trust Regional Reit (LSE: RGL), which invests in regionally diversified property. It represents potentially good value. RGL's current dividend yield is well above the market average, and its portfolio should benefit from a resolution to Brexit as businesses expand.

My hunch is that the current discount to net asset value (NAV, the value of the underlying portfolio) roughly 7% could tighten to 4% or even 3% as more value-orientated investors buy the stock. In the meantime, investors should be picking up a 7.5% yield with the possibility of a 3% increase in the dividend payout next year. RGL's balance sheet is looking healthier and its dividend should be fully covered in the next few months.

Advertisement - Article continues below

Major banks are clients

RGL invests in a diversified portfolio of regional offices and industrial units, 30% around the southeast (but not London) and the Midlands. By my estimates, the portfolio comprises a total of 1,192 units, 874 tenants, and 150 individual properties. In the past, the focus has been in industrial units, especially in Scotland, but many of these legacy assets have been sold off (for good prices).

The proceeds have been reinvested in a portfolio largely made up of offices, many in the south. These offices are not likely to be the very highest grade, but the quality seems more than satisfactory for big corporate clients the largest tenant is Barclays Bank in Glasgow, while others include Bank of Scotland and travel group Tui Northern Europe. The occupancy rate is currently around 90%, while the acquisition yield (rent as a proportion of market value when bought) of most properties is about 8.7%. Rental growth is running at around 2% a year, plus there's scope for active management, which usually implies a big refurbishment programme followed by rent increases.

Recent results were more than satisfactory, with NAV at 115.2p per share, up 16%. That NAV performance was primarily driven by a 4.5% like-for-like revaluation gain in addition to uplifts from disposals. According to fund analysts at Liberum, tenant retention increased to 74%, up from 64% the year before, while lease renewals in 2018 resulted in a 4.2% uplift to passing rent. The net initial yield (rent as a percentage of property value) on the portfolio on 31 December 2018 was 6.5%. The equivalent yield (weighted-average income) stood at 8.2%. In December 2017 the respective figures were 6.5% and 8.3%. The balance sheet also seems to be in decent shape. The loan-to-value ratio is 38.3%, while the cost of that debt is now 3.5%, with an average duration of 7.1 years.

What next for office markets?

The big question is how the regional office will develop over the next few years. Market analysts at IPF forecast total returns of 7.1% a year through to 2022 for industrial property, compared with 4% for offices, casting doubt on the fund's decision to sell those industrial units.

Note too that some think it's the lower-quality regional office market that could be hit hardest if Brexit uncertainty continues to dampen sentiment, while others will be concerned by RGL's fee structure. There's a performance fee of 15% of total shareholder return above 8%, "which is an outlier in the sector and may hinder potential investor interest", according to Liberum analysts.

Nevertheless, the yield seems sustainable and Brexit should provide a boost for this fund in which case investors might well pick up capital gains alongside that income yield.




Why investment trusts are the best vehicle for your money

Max King explains the advantages of investment trusts – sometimes called closed-ended funds – over their open-ended counterparts (or Oeics).
11 Feb 2020
Share tips

Share tips of the week

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
17 Jan 2020

Investment trusts: the Cinderella of investment arrives at the ball

Investors should look beyond the market noise of a single year and examine the bigger picture. Max King explains what we can learn from 25 years of in…
8 Jan 2020
Share tips

Share tips: eight stocks that should deliver robust returns

Ryan Ermey of US publication Kiplinger’s Personal Finance chooses his favourite stocks for the next decade, which should be able to grow for years.
28 Dec 2019

Most Popular

House prices

The biggest risk facing the UK housing market right now

For house prices to stagnate or even fall would be healthy for the property market, says John Stepek. But there is a distinct danger that isn't going …
17 Feb 2020

The euro’s slide against the US dollar looks set to continue

The euro has been in a bear market against the US dollar for two years now. And on a broader scale since 2008. A decline like that is telling us somet…
19 Feb 2020
Share tips

Three overlooked stocks to buy now

Each week, a professional investor tells us where he’d put his money. This week: Joe Bauernfreund, portfolio manager at the AVI Global Trust, highligh…
17 Feb 2020

Is 2020 the year for European small-cap stocks?

SPONSORED CONTENT - Ollie Beckett, manager of the TR European Growth Trust, on why he believes European small-cap stocks are performing well.
12 Feb 2019