Make a juicy income from commercial property

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

944_MW_P20_Funds
The trust has a big presence in Glasgow

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.

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.

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.

Recommended

Why investment trusts are the connoisseur’s choice of fund
Investment trusts

Why investment trusts are the connoisseur’s choice of fund

Investment trusts have justified their reputation as the best type of collective investment in 2020, says Jonathan Davis.
7 Dec 2020
Why investors should take investment trusts up on their free lunches
Investment trusts

Why investors should take investment trusts up on their free lunches

Investment trusts are brilliant, says Merryn Somerset Webb. Perhaps the most brilliant thing of all about them is the fact that investors can meet and…
16 Nov 2020
If you think now is a good time to buy, look at these investment trusts
Investment trusts

If you think now is a good time to buy, look at these investment trusts

With the latest market slides, an awful lot of assets are beginning to look very cheap indeed. If you are thinking of buying, Merryn Somerset Webb has…
10 Mar 2020
How to build a properly diversified investment trust portfolio
Sponsored

How to build a properly diversified investment trust portfolio

Max King explains how to build a well diversified portfolio using one of our favourite tools – investment trusts.
25 Feb 2020

Most Popular

Of course bitcoin is a bubble – a bubble you can’t ignore
Bitcoin

Of course bitcoin is a bubble – a bubble you can’t ignore

Bitcoin’s wild ride is being called a bubble by many. And it is, says Dominic Frisby. But that’s not necessarily a bad thing. And it’s a bubble in whi…
13 Jan 2021
A simple way to profit from the next big trend change in the markets
Investment strategy

A simple way to profit from the next big trend change in the markets

Change is coming to the markets as the tech-stock bull market of the 2010s is replaced by a new cycle of rising commodity prices. John Stepek explains…
14 Jan 2021
I wish I knew what a SPAC was, but I’m too embarrassed to ask
Too embarrassed to ask

I wish I knew what a SPAC was, but I’m too embarrassed to ask

A financial instrument called a “special purpose acquisition company”, or SPAC for short, is growing increasingly popular in the US stockmarkets. But …
12 Jan 2021