Why do two ostensibly similar real estate investment trusts (Reits) trade at such different valuations? AEW UK Reit (LSE: AEWU), with net assets of £174 million, invests in “UK commercial property assets in strong locations” nearly all outside London. Its shares trade on a 4% discount to net asset value (NAV) and yield nearly 8%.
Conversely, Regional Reit (LSE: RGL), with net assets of £362 million, invests in “high quality commercial properties outside of the M25 motorway”. Its shares yield 7.3% but trade on a discount of 44% – even though, as the larger trust, its shares ought to be more liquid.
Part of the answer is down to performance. AEW seeks to buy “mispriced assets” and to apply “active management” to “grow income, lengthen and improve tenant leases, add value using the planning system and refurbish, where needed”. A five-year investment return of 70%, compared with a property sector index of -5%, shows it has succeeded. Meanwhile, RGL’s NAV is down 74% over five years and 70% over three.
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This reflects differences in what the two trusts hold. AEW has 36% in industrial properties, 21% in high-street retail, 13% in retail warehouses, 11% in offices and 18% in “other”. Meanwhile, RGL has 91% in offices, the weakest part of the market. More important is that AEW has kept borrowings to 25% of portfolio value. Its cost of debt is currently below 3%, fixed until May 2027.
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RGL has been less prudent. It has net debt of £260 million, equal to 42% of portfolio value. A disposal programme of 40 properties with a book value of £106 million – partly offset by capital expenditure of £24 million – would cut that to 29%. However, this follows a distressed share issue at 10p in mid-2024, which raised £110 million but heavily diluted the NAV.
The proceeds enabled RGL to repay a £50 million bond, which was about to mature – debt having reached 57% of portfolio value. Following this, there was a one-for-ten share consolidation. The issue was underwritten by Steve Morgan, the founder of housebuilder Redrow. This has left Morgan’s companies with 22% of the shares in issue.
Which Reit to choose?
Steve Inglis, RGL’s chief executive, has described the post-Covid operating environment as “challenging”. However, in May this year he was able to report steady property valuations, an increase in occupancy and 14 new lettings despite a 5% fall in year-on-year rental income. So, with debt falling and rental income improving, RGL appears to have turned a corner, making the discount highly attractive. RGL’s external valuer estimates the open-market rent of the portfolio – 126 properties with 1,271 individual units and 780 tenants – is 27% above the current rent roll, indicating rent increases as current agreements expire. Inglis doesn’t think the regional market is in dire straits and is frustrated by the discount but, at present, investors aren’t listening.
There is less rental upside in AEW’s portfolio – just 9% – but management expects recent acquisitions and planned asset management initiatives “to result in stronger returns in the future.” With 34 properties and 129 tenants, it is more focused than RGL, even taking into account its smaller size, and the portfolio is more diversified.
The current market is “the greatest buying opportunity we have seen in the ten-year life cycle of the company but, perhaps, a less good time to be selling”, says Laura Elkin, AEW’s lead manager. “There is more mispricing in the market, which is absolutely what we want to see, enabling us to buy properties out of line with their long-term fundamentals and then actively manage them.”
For investors, the choice is between a Reit with a great record and good prospects at a price that reflects those factors, and one which is very much a recovery bet with plenty of upside but higher risk.
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