Commercial property at a bargain price

Hansteen should be high up on the buy list for disenchanted buy-to-let investors.

With the rules and tax treatment of buy-to-let becoming ever more stringent, most investors will find better returns for a lot less effort in the property sector of the stockmarket. These companies offer scale, diversity, experienced management, low and tax-deductible borrowing costs and high and growing dividend yields. Moreover, they are eligible for inclusion in an individual savings account (Isa), reducing the tax liability of the investor to zero.

High on the buy-list should be Hansteen (LSE: HSTN), a company founded by Morgan Jones and Ian Watson soon after they sold their previous one, Ashtenne, in 2005. Hansteen (note the anagram) also invests in industrial property (mostly warehouses and distribution depots), but focused initially on Europe rather than the UK. They gradually built up the UK portfolio and in 2017 sold most of their European holdings, having achieved their objectives. More than 95% of the portfolio is now in the UK.

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Hansteen's strategy is simple: acquire selectively; manage intensively; mitigate risk through diversity; generate operational returns with sustainable growth; and deliver consistently high realised returns for shareholders. The 256 properties in the portfolio are divided into 2,700 units and let to 2,399 tenants. The portfolio is valued at £650m, financed by £249m of debt at an average cost of 3.1%, and £456m of equity. There is £55m of cash for future opportunities.

The rental yield of the portfolio at the end of 2018 was 7.1%, but that included a negligible yield on £46m of land with development potential. Strip that out, and the yield climbs to 7.6%. It would rise to 9.2% if all properties were fully let at current open-market rental values. Costs ate into the rental income, but the low cost of debt means that the net rental income, nearly all of which was paid out to investors as dividends, was more than 6% of net asset value (NAV, the value of the underlying portfolio).

With the shares trading at a 10% discount to NAV, the historic yield is 6.7%. Moreover, property revaluations added nearly 10p to NAV in 2018, though most of this was offset by the cost of management's long-term incentive plan, the closure of which resulted in the issue of 22 million shares to Jones and Watson. This focuses their attention on enhancing value for investors, rather than empire building, and resulted last year in the return of £145m 35p a share to shareholders following some large disposals at a time of limited opportunities for reinvestment. This return of capital will lead to a corresponding reduction in dividends, though the yield will still be more than 5%, "from where dividends will return to growth," says Jones.

Continued rewards

Management also points out that capital values are underpinned by being "well below replacement cost", while acquiring their portfolio in the open market would add transaction costs of around 6% to asset values.

Much of the property sector is currently in the doldrums, but Hansteen has generated an average return on capital of 13% since flotation and 18% between 2013 and 2018. Returns will probably slow but a return to the long-term average would generate few complaints. Don't wait until the end of the tax year to put this into your Isa for 2019/20.