UK Commercial Property REIT Ltd – Net Asset Value at 30 June 2022

10 August 2022

UK Commercial Property REIT Limited
(“UKCM” or “the Company”)

Net Asset Value at 30 June 2022

EARNINGS AND ASSET MANAGEMENT LED VALUATION GROWTH SUPPORT FURTHER DIVIDEND INCREASE

10 August 2022: UK Commercial Property REIT Limited (“UKCM” or the “Company”) (FTSE 250, LSE: UKCM), which owns a £1.7 billion portfolio of high quality and diversified real estate across the UK today provides a net asset value (“NAV”) and trading update for the second quarter of 2022.

Highlights

  • 1.5% increase in NAV per share to 112.9p (31 March 2022: 111.2p) resulting in NAV total return for the quarter of 2.3% (Q1: 9.8%). This brings NAV growth for the first half of 2022 to 10.7% and first half NAV total return to 12.3%.
  • 1.4% increase in like-for-like portfolio capital value, net of capital expenditure, to £1.71 billion, against the Company’s benchmark, the MSCI UK Balanced Portfolios Quarterly Property Index, which increased by 2.1% over the quarter. The portfolio has outperformed its MSCI benchmark over 1, 3 and 5 years.
  • Rent collection rates have normalised to pre-pandemic levels with 99% received for the third quarter of 2022 and 99% for the year to date.
  • Quarterly dividend increased by a further 6.3% to 0.85p per share, following the increases announced in both the fourth quarter of 2021 and the first quarter of 2022. This brings the H1 2022 dividend increase to 13.3%.
  • Additional special dividend of 1.92p per share payable in August to reflect strong gains realised
  • 9% increase in EPRA earnings per share for the quarter to 0.83p (31 March 2022: 0.76p) giving dividend cover for the quarter of 104%.

Ken McCullagh, Chair of UKCM, commented: “We have delivered a strong set of results from our portfolio during the first half of 2022 with further positive leasing momentum by our asset management team driving rental growth and an increase in portfolio valuation.  Over the past few years we have taken advantage of our ability to invest in a diversified range of sectors to proactively manage our portfolio towards income growth and security, with a focus on future fit and operational asset classes.  Of particular note we have built a strong position in both urban and big box logistics, and the living assets class, where we are invested in student housing and hotels – in all of these the supply demand imbalance and societal changes continue to be highly supportive of the occupational markets and rental growth.  While we are acutely aware of the broader economic challenges ahead, including rising inflation and interest rates, that could be negative on valuations, we believe that we are well placed both in terms of the quality of our portfolio and the strength of our lowly leveraged balance sheet, to continue to deliver shareholder value through a growing level of income.  This confidence is reflected in the additional – and fully covered – dividend increase we have announced today.

The Board, as noted in recent prior statements, is conscious of the significant discount on the share price to NAV.  The Board is pleased to announce the payment of a special dividend of 1.92p per share in August to return some of the strong gains that have been realised over the last number of quarters from capital allocation and asset management initiatives so that all shareholders can benefit from the recent growth in net asset value that is not currently reflected in the Company’s share price.  The Board believes this type of distribution could be utilised in the future to reward shareholders, while still also keeping the option of share buy-backs under consideration.

With Will Fulton having returned to the Manager full time, I would also like to take the opportunity to thank Kerri Hunter, who stood in for Will during his temporary absence, particularly for her efforts in helping the abrdn team fully deploy our remaining cash resources at the end of last year.  We wish her well on her future endeavours.”

Positive Investment Activity

As previously disclosed, in May, the Company committed to the development of a high quality hotel in central Leeds which will complete mid-2024 with a 25-year franchise agreement in place with Hyatt Hotels, one of the leading global hotel brands. UKCM is funding the development for a total commitment of £62.7 million. The hotel will be operated under a lease by Interstate Hotels & Resorts, a 50+ year old global leader in hotel operation, with UKCM’s rental income based on the income generated from the operation of the hotel. The acquisition is in line with part of UKCM’s strategy to invest in operational real estate sectors that are expected to deliver resilient rental incomes.

The 140,000 sq ft hotel’s 305 rooms will be split between the short stay Hyatt Place and the long stay Hyatt House brands. The upscale hotel will provide meeting rooms, a gym and several food and beverage options, including a rooftop bar with its own dedicated entrance.

Outside the reporting period in July the Company disposed of its 68,400 sq ft central Birmingham office, 9 Colmore Row, to Birmingham City Council at a price of £26.48 million, ahead of the asset’s book cost and at a premium to the latest valuation. In addition to securing a strong sale price, the disposal is in line with the Company strategy of exiting risk assets and those in need of capital expenditure which will not enhance value.

Asset management driving rental growth, occupancy and value

The Company has a very low void rate of 1.5% (2.4% at Q1 2022) which provides good visibility of future income and clearly demonstrates the asset management team’s ability to grow income, with a strong focus on capturing the portfolio’s reversionary potential whilst also driving value. 

Notable transactions over the last quarter include:

  • In June, a new tenant was secured for Unit 12, Newton’s Court, Dartford following a comprehensive refurbishment and environmental upgrade of the property. Paak Logistics UK Limited has taken a new 15 year lease without break over the 67,300 sq ft unit at a rent of £942,816 per annum, representing a 27% premium to the ERV at the start of the year and demonstrating the continued demand for high quality, well located logistics space. This also sets a new headline rental tone for the estate of £14psf per annum and the lease incorporates 5 yearly upwardly only open market rent reviews. The achieved rent is significantly ahead of the original underwritten rental level when the refurbishment commenced demonstrating the potential within the portfolio to capture strong rental growth. In line with the Company’s ESG priorities the buildings EPC was improved from a rating of D to A through the refurbishment works which included using energy efficient materials and installing PV panels. 
  • Also at Newton’s Court Dartford, Unit 6 was let to Rodenstock UK Ltd on a new 10 year lease with a tenant only break option in year 5 over the 6,650 sq ft unit which had recently fallen vacant.  The agreed annual rent is £89,775 per annum equating to £13.50 psf per annum, which is 6% ahead of the unit’s previous ERV at the start of the year. Overall Newton’s Court, Dartford has experienced 9% growth in market rents in the first six months of the year.
  • At Craven House, the Company’s 20,100 sq ft West End office, the rent review from June 2021 was settled 5% ahead of ERV at an increased rent equating to £54 per sq ft. The prominent building is situated adjacent to Carnaby Street and is let to film and television production company Molinaire until June 2026.   
  • As previously disclosed, at St George’s Retail Park in Leicester, Autoglass completed a new 10 year lease in June, with a tenant break on the fifth anniversary at a rent of £52,500 per annum in line with ERV. The park is now fully let and boasts an attractive line-up of strong tenants including Next, Home Bargains, DSG and Iceland.

Strong balance sheet with significant covenant headroom and flexibility

  • Robust and efficient balance sheet with low gearing and financial resources of £24 million available to utilise from current resources, including the post-period receipt from the sale of Colmore Row, and allowing for future commitments and the dividends payable in August 2022.
     
  • At 13.7% the Company’s gearing continues to be one of the lowest in the AIC peer group which averaged 20% at the end of June. The drawn debt has an overall blended interest rate of 2.79% per annum, of which 75% is fixed rate, with a weighted maturity of 5.4 years and banking covenants that are well covered.

Rent Collection has normalised

  • Rent collection rates have normalised with payments received so far for third quarter rents reflecting 99% of rents due as at close of business on 30 July 2022, (collectively the 24 June and 1 July English, and 28 May Scottish, quarterly billing dates) after allowing for agreed rent deferrals and including those tenants who have paid, by agreement, on a monthly basis.

The table below sets out the third quarter’s rent collection, split between sectors:

% of Q3 2022 rent demanded % collected
Industrial  54% 99.8%
Office  18% 98.2%
Retail  15% 98.4%
Other   13% 100%
Total 100% 99.3%

The Company has a diverse tenant mix with a number of high quality occupiers, the largest five of which comprise resilient businesses such as Ocado (6.0% of rent), Public Sector (5.0%) Warner Brothers (4.4%), Amazon (4.2%) and Total (3.3%).

The second quarter dividend has been increased by a further 6.3% to 0.85p per share. This follows a 6.7% increase for the prior quarter and reflects the Board’s continued recognition of the importance of income to shareholders. Dividend cover for the second quarter of 2022 was 104%, compared to 101% for the first quarter of 2022 and the Board believes the further increase to be appropriate and sustainable given the current level of investment and development activity within the Company.

The Board, as noted in recent prior statements, is conscious of the significant discount on the share price to NAV.  The Board is pleased to announce the payment of a special dividend of 1.92p per share in August to return some of the strong gains that have been realised over the last number of quarters from capital allocation and asset management initiatives so that all shareholders can benefit from the recent growth in net asset value that is not currently reflected in the Company’s share price.  The Board believes this type of distribution could be utilised in the future to reward shareholders, while still also keeping the option of share buy-backs under consideration.

Discount Policy / EGM

The Company’s discount control policy provides that if the market price of the ordinary shares of 25 pence each in the Company (the “shares”) is more than 5 per cent below the published NAV for a continuous period of 90 dealing days or more, following the second anniversary of the Company’s most recent continuation vote in relation to the discount control policy, the Directors will convene an extraordinary general meeting to be held within three months to consider an ordinary resolution for the continuation of the Company. The most recent continuation vote in relation to the share discount policy was held on 18 March 2020.

The closing market price of the shares had been more than 5 per cent below the published NAV for more than 90 continuous days up to 29 July 2022. In accordance with the discount control policy, the Board is therefore intending to convene an extraordinary general meeting to consider a resolution to approve the continuation of the Company.

The Investment Manager continues to improve earnings and identify attractive opportunities for the Company’s property portfolio and the Board believes it is important for shareholders to approve the continuation vote in order that the Investment Manager may continue to pursue the investment strategy effectively. Accordingly, the Company will, in due course, be publishing a circular convening an extraordinary general meeting to consider that continuation resolution and the Board will be recommending shareholders vote in favour of the Company’s continuation.

The Company has discussed the upcoming resolution with its largest shareholder, Phoenix, which currently holds in aggregate approximately 43.4 per cent of the Company’s issued shares, and which has indicated it intends to vote in favour of continuation.

Breakdown of NAV movement

Set out below is a breakdown of the change to the unaudited net asset value per share calculated under International Financial Reporting Standards (“IFRS”) over the period from 31 March 2022 to 30 June 2022:

UK Commercial Property REIT Limited Per Share (p) Attributable Assets (£m) Comment
Net assets as at 31 March 2022 111.2 1,444.9
Unrealised increase in valuation of property portfolio 3.4 44.2 Predominantly increase in property portfolio
Capex -1.7 -22.1 Predominantly relates to capex for the ongoing student accommodation developments at Exeter and Edinburgh, the industrial unit developments at Sussex Junction and Leamington Spa and the purchase of land for development at Sovereign Square, Leeds.
Income earned for the period 1.3 16.5 Equates to dividend cover of 104%.
Expenses for the period -0.5 -5.7
Dividend paid on May 2022 -0.8 -10.4
Net assets as at 30 June 2022 112.9 1,467.4

The EPRA Net Tangible Assets per share is 112.9p (31 March 2022: 111.2p) with EPRA earnings per share for the quarter being 0.83p (31 March 2022: 0.76p).

Sector Analysis

Portfolio Value as at 30 Jun 22 (£m) Exposure as at 30 Jun 22 (%) Like for Like Capital Value Shift (net of CAPEX) Capital Value Shift (including sales & purchases & development spend)     (£m)
(%)
Valuation as at 31 Mar 22 1,665.5
Industrial 1,092.5 63.8 1.3 20.9
South East 39.7 0.7 11.7
Rest of UK 24.0 2.2 9.2
Retail 212.7 12.5 5.5 11.1
High St – South East 0.9 0.0 0.0
High St- Rest of UK 1.1 0.0 0.0
Retail Warehouse 10.5 6.6 11.1
Offices 227.6 13.3 0.6 1.4
West End 1.8 5.9 1.7
South East 5.0 0.0 0.0
Rest of UK 6.5 -0.3 -0.3
Alternatives 178.2 10.4 -1.6 12.1
External valuation at 30 Jun 22 1,711 100.0 1.4 1,711

The independent valuation as at 30 June 2022 was carried out by CBRE Ltd.

Net Asset Value analysis as at 30 June 2022 (unaudited)

       £m % of net assets
Industrial 1,092.5 74.5%
Retail 212.7 14.5%
Offices 227.6 15.5%
Alternatives 178.2 12.3%
Total Property Portfolio 1,710.9 116.7%
Adjustment for lease incentives -32.4 -2.2%
Fair value of Property Portfolio 1,678.5 114.5%
Cash 34.3 2.3%
Other Assets 56.2 3.8%
Total Assets 1,768.9 120.7%
Current liabilities -35.0 -2.5%
Non-current liabilities (bank loans) -266.5 -18.2%
Total Net Assets 1,467.4 100.0%

The NAV per share is based on the external valuation of the Company’s direct property portfolio as at 30 June 2022. It includes all current period income and is calculated after the deduction of all dividends paid prior to 30 June 2022.

The NAV per share at 30 June 2022 is based on 1,299,412,465 shares of 25p each, being the total number of shares in issue at that time.

Investment Manager’s Market Commentary and Sector Outlook

Having started on a very positive footing, with the UK economy recovering well from the impact of Covid, this initial optimism was soon curtailed with the advent of war in Ukraine impacting global markets and creating further uncertainty.  As with the pandemic, the focus was put firmly back on supply chains, with rising prices providing further headwinds for the UK, like all economies, with economic growth and inflation firmly in the spotlight.

UK Gross Domestic Product (GDP) surprised to the upside in May 2022 and grew by 0.5%, following two consecutive monthly declines in April (-0.2%) and March 2022 (-0.1%). Consumer sentiment appeared more dampened as wholesale and retail sales fell by 0.8% over May, with the “cost-of-living crisis” placing pressure on household disposable income levels. Looking forward the short-term risk to the UK economy is that rising energy prices and associated real-income squeeze will lead to a fall in activity and growth. The medium-term risk is that monetary tightening by the Bank of England to tackle underlying pressures tips the economy into recession in late 2022/early 2023.

Overall the abrdn Research Institute (aRI) is forecasting a peak-to-trough decline in the level of GDP of around 1.4% during this sustained period of economic weakness over the next two years. This should be sufficient to help blunt inflationary pressures over the second-half of the inflation profile. Indeed, UK inflation, as measured by the consumer price index (CPI), rose from 9.1% in May to 9.4% in June, a level last seen in 1982. Inflation is likely to keep increasing due to rising food and energy prices, with the latter expected to move higher in October when Ofgem increases the energy price cap. However, inflation is then expected to fall as challenging base effects and slowing economic growth influence headline inflation. aRI is currently forecasting UK CPI to end the year at 8.5%, before falling to 5.2% and 1.7% in 2023 and 2024 respectively. 

As a result, in an attempt to quell the inflation rate, the Bank of England is expected to continue to hike interest rates over the next few meetings, with the terminal interest rate estimated to reach 2.25% later this year, despite the predicted slowdown in activity. After a series of front-loaded interest rate rises in 2022, the Bank of England is likely to pause its hiking cycle. It may then reverse the increases, with a cutting cycle starting in the fourth quarter of 2023 which could eventually take rates back to the effective lower bound of 0.1% in 2024. However, the risks of inflation remaining stubbornly high, and above the Bank of England’s target rate of 2%, are skewed to the upside.

Commercial Property

UK real estate carried some of its positive performance momentum from 2021 into the early part of 2022. However, this year will likely be one defined by the proverbial ‘two halves’ as some of the strong performance in the first half of the year is expected to be unwound moving forward. With sentiment towards UK real estate weakening, investment volumes have slowed as the market pauses for breath and takes stock.

Over the first half of the year, performance remained very positive and, at an all property level, the UK real estate market delivered a total return of 9.6% over the first six months of 2022. As expected, the industrial and logistics sector continued to drive the market and posted a total return of 5.1% in the second quarter, whilst over the same period the office sector once again provided the weakest performance at 1.7%. The retail sector recorded another strong quarter in Q2 and provided a total return of 3.8%, but much of this positive performance was attributable to the retail warehouse sector, which provided a robust total return of 5.2% in the second quarter according to the MSCI monthly index.

Transaction volumes in the first half of 2022 remained very robust and UK real estate recorded the strongest first half investment volumes since 2015 according to Real Capital Analytics (RCA). A total of £31.2 billion was transacted over this period; however, approximately two thirds of the activity occurred in the first quarter of 2022. Investment volumes were £10.2 billion in the second quarter of 2022, which was lower than the Q2 10-year average of £13.5 billion. The slowdown in investment activity towards the end of the second quarter of 2022 can largely be attributed to the emergence of a less accommodative monetary policy environment as the Bank of England tries to bring inflation back closer to its target rate of 2%. This has resulted in slowing economic growth expectations, rising bond yields, and an increased cost of capital for debt-backed real estate investors, which has caused weaker sentiment towards UK real estate at this time.

The industrial sector experienced a record year in 2021 in terms of both performance and transaction volumes and carried this momentum into 2022. However, with the weakening economic environment, the sector has begun to slow and investor sentiment has begun to cool somewhat. Whilst reflected in a slowing level of transaction volumes, occupier markets have seen strong performance, with leasing driven by the imbalance between supply and demand. Amazon’s announcement in April 2022 that it was to reduce its operational estate surprised the market, but we believe this statement was primarily focused on the US and, more importantly, that occupational demand is and has proven to be more multi-faceted and deeply diverse than being wholly reliant on one operator or business segment. The industrial sector continues to benefit from longer term thematic tailwinds and rental value growth should remain positive in response to tight supply levels, but return to a more normalised growth rate.

Polarisation within the office sector has been gathering pace as both occupiers and investors continue to narrow their focus on best in class office assets with strong environmental credentials. There have been increased reports of positive letting activity in the office sector over the second quarter of 2022. But, according to CBRE, the central London vacancy rate remains elevated at 9%. Secondary accommodation accounts for approximately 70% of all available accommodation. Overall office demand is expected to fall as a poorer economic outlook weighs on job growth across the market, placing additional pressure on occupational sentiment. However Grade A ‘future fit’ office assets, in prime locations, are anticipated to be more resilient in this weakening environment, whilst the outlook for secondary assets is much more challenging.

The UK retail sector was showing tentative signs of green shoots at the start of 2022, but momentum, particularly in the occupational market, is expected to experience a marked slowdown as the current cost-of-living crisis and slowing economic growth puts pressure on consumer spending. This will be more acutely felt in the consumer discretionary and fashion-led part of the market. Essential, discount and convenience-led retail is expected to be much more resilient in this environment, but not entirely immune to the cost-of-living pressures facing UK households. Retail sales volumes fell by 0.5% in May 2022 and, in the three months to May 2022, by 1.3% when compared to the previous 3 months, continuing a downward trend that began in summer 2021. Foodstore sales provided the largest contribution to the fall in sales over May, as sales fell a further 1.6%. This supports the view that consumers are seeking to reduce their outgoings in the face of rising costs.

Strong demographics and structural tailwinds are expected to continue to drive interest in the alternative sectors, particularly in healthcare, Build-to-Rent and student housing over the medium-to-long term. With the occupational pressures facing the office and retail markets, investor allocation to alternative sectors more generally is expected to grow. However, these sectors are not immune to the weakening macro environment and a focus on quality will be important to ensure performance remains resilient.

Investment Outlook

Looking forward we expect some of the strong first half 2022 performance to be unwound over the second half and, given the current market environment, our overall outlook for the next 12-18 months has been revised downwards.

In June 2022, the spread between UK real estate and UK 10 year gilts reached the lowest level since 2008 as the UK 10 year yield peaked at 2.65% in response to increasing inflation and interest rate expectations. Whilst the yield has since fallen back from this level, we expect the yield on UK gilts to remain at or above 2% in the near-term, meaning that a smaller margin between gilts and UK real estate will likely remain in the near term. On top of this, with rising debt costs driven by tightening monetary policy, a number of leveraged players have begun to step back from the market as the cost of debt outstrips yields in several sectors making its use in these sectors prohibitive. As a result we are now expecting some repricing across the UK real estate market, driven predominantly by interest rates ‘re-rating’ and an increased cost of capital impacting yields.

Investors are anticipated to take a more risk off approach towards UK real estate in the second half of this year and we expect polarisation of investor focus to widen, as investors target best in class assets which should provide more resilient returns in a weakening environment, with greater scrutiny on the resilience of income streams.

ESG considerations are expected to become even more integral to investor decision making and asset underwriting. This trend was expedited as a result of the Covid-19 pandemic, but with the current energy crisis and pathway to net-zero, the case for integrating ESG considerations across all UK real estate sectors has never been greater. A greater emphasis on ESG requirements for both acquisitions and developments is expected.

Whilst we expect a slowdown in the market in the near term, with polarisation between best in class and secondary assets expected to intensify, we also expect inflation to fall sharply into 2024 with the Bank of England anticipated to start reversing its interest rate hikes, with a cutting cycle starting in 2023 and resulting in rates returning to 0.1% by 2024. Consequently, we would expect the overall cost of debt to move lower, in line with the UK policy rate, and become more widely available as the economic environment and investor sentiment towards UK real estate improves. UK government bond yields will also move lower, in line with the expectation of a more accommodative monetary policy environment.  We therefore expect a relatively short period of increasingly tight spreads over the next 18-24 months, before UK real estate begins to look more attractive to investors again. Opportunities within the market should emerge once repricing has occurred and a rebound in real estate performance is anticipated.

The information contained within this announcement is deemed by the Company to constitute inside information as stipulated under the Market Abuse Regulations (EU) No. 596/2014). Upon the publication of this announcement via Regulatory Information Service this inside information is now considered to be in the public domain.

Details of the Company may also be found on the Company’s website which can be found at: www.ukcpreit.com

For further information please contact:

Will Fulton / Jamie Horton, abrdn

Tel: 0131 528 4261

William Simmonds, J.P. Morgan Cazenove

Tel: 020 7742 4000

Richard Sunderland / Andrew Davis / Emily Smart, FTI Consulting

Tel: 020 3727 1000

UKCM@fticonsulting.com

The above information is unaudited and has been calculated by abrdn.

 

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