An inconspicuous recent announcement by Regional Reit (LSE: RGL) caught my eye. The real-estate investment trust was buying a £236m portfolio of 31 assets, comprising more than 1.6 million square feet in 27 office assets with 192 tenants, two industrial units with three tenants, three residential assets with 12 tenants and a drive-through restaurant.
A Reit on the rise
RGL has been a dull investment since its launch in 2015. At 90p, its shares trade half-way between its early 2020 high of 120p and its October 2020 low of 60p. They stand at a 9% discount to net asset value (NAV), which is now slightly below the 100p at launch, but offer a dividend yield of 7%.
RGL invests in property, predominantly offices, outside the M25. Rent collection last year was 96% of the expected total. These are good-quality buildings with post-acquisition occupancy of 83%. A £732m portfolio at the start of the year was financed by £426m of equity and £373m of net debt with an average duration of 6.4 years and cost of 3.3%.
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There was also £67m of cash for acquisitions and to provide headroom at the start of the year. Offices make up 83% of the portfolio and yield 6.8%, but the reversionary yield (the yield produced when the current rent is adjusted to the estimated rental value) is 9.6%. The reversionary potential on the industrial assets, which yield 7%, is 8%.
So RGL shares looked attractive even before the recent acquisition with a generous yield, a good discount to NAV, and the prospect of steady growth in income and dividends. The yield on the acquired properties, however, is 7.8% and the reversionary yield 11%, which looks too good to be true.
With interest rates low, the economy growing at a good clip and no glut of empty properties overhanging the market, the economic conditions for forced selling do not appear to exist. Financing of the acquisition is £77m from cash, £76m from additional debt and £83m in shares issued to fund manager Squarestone Growth (a regional-office fund) at NAV, which it is committed to retaining. Squarestone clearly does not lack confidence in RGL or in the portfolio it has sold to it, and there is no evidence that it is in distress.
Alan Brierley of Investec Securities points out in a recent research note that there are plenty of distressed property sellers – not listed Reits, but open-ended property funds with supposed daily or weekly liquidity.
Open-ended funds’ flaw
Investment companies “appear to have moved onto the front foot” but “structural flaws continue to be a dragging anchor for open-ended funds. Since these reopened they have experienced a tsunami of redemptions.” The largest open-ended funds have made some gains, but aggregate assets of the ten largest funds have fallen from £13bn to £8.7bn in just nine months. Two have decided to close.
Over the year to 30 June, the average investment company’s NAV total return is 11.3%, while the average open-ended fund’s total return is -0.6%. Many open- ended funds are in a “doom loop” – to meet potential redemptions, they need to hold cash (£1.6bn in the top ten funds), which drags on returns. This leads to poor performance, disillusioned investors and redemptions.
By contrast, closed-end funds, including Reits, don’t have the redemptions problem as the number of shares are fixed, while they can also take advantage of cheap borrowing to enhance returns. Investors risk the shares falling to a discount to NAV, but know that their companies will never be distressed sellers.
That might not explain RGL’s bargain-basement acquisition, but does make it likely that there will be plenty more value-accretive acquisitions in the Reit and broader property sector, much of which still trades on an attractive discount to NAV.
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