Custodian REIT plc : Unaudited Net Asset Value as at 30 September 2018

23 October 2018

Custodian REIT plc

("Custodian REIT" or "the Company")

Unaudited Net Asset Value as at 30 September 2018

Custodian REIT (LSE: CREI), the UK commercial real estate investment company, today reports its unaudited net asset value ("NAV") as at 30 September 2018 and highlights for the period from 1 July 2018 to 30 September 2018 ("the Period").

Financial highlights

• NAV total return per share1 for the Period of 2.3%
• Dividend per share approved for the Period of 1.6375p
• NAV per share of 108.6p (30 June 2018: 107.8p)
• NAV of £427.5m (30 June 2018: £416.9m)
• Net gearing2 of 20.5% loan-to-value (30 June 2018: 21.0%)
• £8.4m3 of new equity raised during the Period at an average premium of 13.2% to dividend adjusted NAV per share at 30 June 2018
• Market capitalisation of £478.1m (30 June 2018: £467.3m)

Portfolio highlights

• Portfolio value of £547.0m (30 June 2018: £537.4m)
• £19.2m4 invested in five property acquisitions, one development and one refurbishment
• £2.2m valuation increase from successful asset management initiatives
• EPRA occupancy5 96.9% (30 June 2018: 96.7%)
• £4.4m6 gross profit on disposal of two properties for an aggregate consideration of £13.1m

1 NAV per share movement including dividends approved for the Period.

2 Gross borrowings less unrestricted cash divided by portfolio valuation.

3 Before costs and expenses of £0.1m.

4 Before acquisition costs of £1.1m.

5 Estimated rental value ("ERV") of let property divided by total portfolio ERV.

6 Before disposal costs of £0.1m.

Net asset value

The unaudited NAV of the Company at 30 September 2018 was £427.5m, reflecting approximately 108.6p per share, an increase of 0.7% since 30 June 2018:

7 Dividends of 1.6375p per share were paid on shares in issue throughout the Period.

During the Period the initial costs (primarily stamp duty) of investing £19.2m (before acquisition costs) diluted NAV per share total return by 0.3p, partially offset by raising new equity of £8.3m (net of costs) at an average 13.2% premium to dividend adjusted NAV, which added 0.2p per share.

The NAV attributable to the ordinary shares of the Company is calculated under International Financial Reporting Standards and incorporates the independent portfolio valuation as at 30 September 2018 and income for the Period but does not include any provision for the approved dividend for the Period to be paid on 30 November 2018.

The Company completed the following investments during the Period:

• Acquisition of a car dealership in Shrewsbury occupied by TJ Vickers for £1.675m, with a net initial yield8 ("NIY") of 6.75% and a weighted average unexpired lease term to first break or expiry ("WAULT") of seven years;
• Acquisition of two car dealerships in Stafford and Shrewsbury occupied by VW Group UK Limited for an aggregate purchase price of £7.375m, with a NIY of 6.38% and a WAULT of six years;
• Acquisition of a distribution unit on Hilton Business Park, Derby occupied by Daher Aerospace Limited for £5.585m, with a NIY of 6.72% and a WAULT of 13 years;
• Acquisition of an office building within Riverside Exchange, Sheffield occupied by branches of the Home Office and the Health and Safety Executive for £3.56m, with a NIY of 9.79% and a WAULT of four years; and
• Capital expenditure of £1.0m, primarily on the development of a Starbucks drive-through restaurant in Maypole, Birmingham and the refurbishment of a multi-let office building in Birmingham.

8 Passing rent divided by property valuation plus assumed purchaser's costs.

Asset management

Owning the right properties at the right time is a key element of effective portfolio management, which necessarily involves some selling from time to time to balance the portfolio.  While Custodian REIT is not a trader, identifying opportunities to dispose of assets significantly ahead of valuation, or that no longer fit the Company's investment strategy, is important.  During the Period the following properties were sold:

• An industrial unit in Southwark for £12.0m, £4.4 million (58%) ahead of its 30 June 2018 valuation.  The lack of available investment stock in Central London, strong investment demand and a recent, substantial rental increase had led to significant recent valuation increases.  In addition, redevelopment potential and the identification of a special purchaser offering a NIY of 2.95% allowed us to crystallise a substantial profit; and
• A town centre retail unit in Dumfries for £1.125m, in line with its 30 June 2018 valuation, as we did not anticipate future rental growth.

A continued focus on active asset management including rent reviews, new lettings, lease extensions and the retention of tenants beyond their contractual break clauses resulted in a £2.2m valuation increase in the Period, primarily due:

• Letting the Company's largest vacant property, an industrial unit in Tamworth, to ICT Express on a 10 year lease without break at a 28% higher rent, which increased the valuation by £1.3m;
• Agreeing a new 10 year lease with Teleperformance of an industrial unit in Ashby-de-la-Zouch, with annual rent increasing by 15% to £0.5m, which increased the valuation by £0.5m;
• Documenting a reversionary lease with Synergy Health at an industrial building at Sheffield Parkway to extend the lease by 7.5 years until 2034 and adjust the rent review pattern to increase in line with RPI, which increased the valuation by £0.2m;
• Securing an open market 10% rental increase at an office in, Grove Park, Leicester which increased the valuation by £0.1m; and
• Securing an open market 7% rental increase at a public house in High Wycombe, which increased the valuation by £0.1m.

Further initiatives on other properties currently under review are expected to complete during the current quarter, although growth in rents and positive asset management outcomes have been tempered by the following recent events: 

• The company voluntary arrangement ("CVA") of Homebase resulted in the Company experiencing a 35% annual rent reduction from £524k to £341k, but with the opportunity to terminate the lease if better terms can be agreed with an alternative tenant.  The property is centrally located in Leighton Buzzard, adjacent to Tesco and Aldi;
• In Milton Keynes, the CVA of Office Outlet (formerly Staples) resulted in the tenant contracting into 50% of the space previously occupied, with rent halving from £419k pa to £209k pa; and
• In Crewe we took the difficult decision to implement a forfeiture of the lease of a Bowling operator which failed to pay its rent, protecting the Company's position and opening up the opportunity of re-letting to a stronger tenant.  Passing rent on the unit was £200k pa.

The portfolio's WAULT decreased from 5.9 years at 30 June 2018 to 5.6 years principally due to the natural 0.25 of a year's decline due to the passage of time over the Period, with the positive impact of acquisitions and asset management activities offset by the CVA rent reductions and lease forfeiture.

Property market

Commenting on the commercial property market outside London, Richard Shepherd-Cross, Managing Director of Custodian Capital Limited (the Company's discretionary investment manager) said:

"Investment market demand has continued in Q3 from property companies, institutions, private investors and from overseas investors.  While there have been marginal outflows from the open-ended funds and many REIT's are trading at a discount to NAV, the demand for income focused investments has not abated.  The rise in UK interest rates was sufficiently well forecast that it had an imperceptible impact on the market and there does not appear to be an imminent threat of meaningful rate rises in prospect.

"The continued demand for industrial/logistics properties has led to the sector showing the lowest initial yields in regional markets.  This is in large part explained by the rental growth prospects in the sector, which are being driven by both occupational demand but more crucially a lack of supply.  This has led to an increase in speculative development, principally of 'big box' logistics units.  We have yet to witness an increase in the development of smaller or mid-sized industrial units, so the rental growth dynamics might be stronger at this end of the market.  The strength of the industrial market was evident in the sale of the Company's industrial building in Southwark.  Not only had we recently secured a rental uplift from £9 per sq ft to £16 per sq ft, demonstrating extraordinary rental growth, but we managed to sell the property for a price reflecting a NIY of 2.95%, based on the increased rent.  Industrial property remains a very good fit with the Company's strategy, but recent price Inflation is limiting the opportunity to acquire properties that meet the investment mandate.  Notwithstanding this challenge, we added to the industrial sector of the portfolio during the Period and I expect the sector to remain a strong driver of rental growth for the Company.

"Investment in the regional office market has also been consistently strong, which has coincided with a number of the UK's 'big six' regional cities hitting record rental levels for prime offices.  Like the industrial sector it is restricted supply, the lack of development and the extensive conversion of secondary offices to residential which is maintaining the upward pressure on rents.  However, we are conscious that obsolescence and lease incentives can be a real cost of office ownership, which can hit cash flow and be at odds with the Company's relatively high target dividend, so we remain very selective, although open to opportunities.

"There is a general move against retail, as many institutional investors feel overweight in the sector in a quarter when we have also witnessed an increase in CVA activity.  While the easy explanation for the changing retail market is the rise of online retailing, the real picture is much more complex.  Over-gearing, poor management strategy and an inability to modernise over an extended period of time has had a more detrimental impact on certain retailers than the internet.  The challenge in the retail sector is not so much identifying the retailers who will prevail in the modern retail environment, but to identify trends in rental levels in both retail sub-sectors and locations.  In many locations rents need to adjust to support retailers, not least because labour costs and business rates are rising.

"We generally feel comfortable that retail warehousing, with low rents per sq ft, 'big box' formats and free parking will be more robust than the High Street.  Following in the footsteps of the USA the UK retail landscape is increasingly polarising, with robust city centre retail in the major conurbations where the experience of retail and leisure together has remained attractive, and resilient out of town retail in smaller towns where convenience and choice is the stock-in-trade.

"There is continued weakness in secondary high street retail locations with rental levels still under pressure and a very real threat of vacancy, but retailers are still keen to have representation on prime high streets.  The challenge across all high street retail locations is to understand where rental levels will settle following the current retail shakeout.  We will continue to rebalance the portfolio to focus on strong retail locations while working on an orderly disposal of those assets we believe are ex-growth.

"Across the portfolio we settled five rent reviews and agreed two new lettings during the Period which have shown a weighted average increase in rents of 9.5%.  This growth has come from a mix of open market lettings and rent reviews in industrial and office properties together with one public house and two RPI linked rent reviews, one in retail warehousing and one in the motor trade.  This demonstrates the continuing opportunity to enhance earnings across Custodian REIT's diverse regional portfolio."

Portfolio Analysis

At 30 September 2018 the Company's property portfolio comprised 151 assets with a NIY of 6.59%.  The portfolio is split between the main commercial property sectors, in line with the Company's objective to maintain a suitably balanced investment portfolio.  Slight swings in sector weightings are reflective of market pricing at any given time and the desire to maintain an opportunistic approach to acquisitions.  Sector weightings are shown below:

9 Current passing rent plus ERV of vacant properties.

10 Includes car showrooms, petrol filling stations, children's day nurseries, restaurants, gymnasiums, hotels and healthcare units.

£3.2m of the valuation decrease within the retail warehouse sector was due to the CVA's of Homebase and Office Outlet (formerly Staples) impacting the Company's units in Leighton Buzzard and Milton Keynes respectively.

The Company operates a geographically diversified portfolio across the UK, seeking to ensure that no one area represents the majority of the portfolio.  The geographic analysis of the Company's portfolio at 30 September 2018 was as follows:

11 Current passing rent plus ERV of vacant properties.

For details of all properties in the portfolio please see www.custodianreit.com/property-portfolio.

Activity and pipeline

Commenting on pipeline, Richard Shepherd-Cross said:

"The benefit of a diversified investment strategy is that it allows us to review all sectors and regions of the UK to identify opportunities that will support the dividend policy.  This has allowed us to acquire £18.2m of assets in the last quarter at an average NIY of 7.16%.  We have a committed pipeline of opportunities with terms agreed totaling £27.1m at an average NIY of 6.45% which keeps us on course for the year in relation to target income yield.  Looking ahead, we are not averse to making judicious, contra-cyclical acquisitions where we believe that short-term market weakness can unlock long term value for the Company."

Financing

Equity

The Company issued 7m new ordinary shares of 1p each in the capital of the Company during the Period ("the New Shares") raising £8.4m (before costs and expenses).  The New Shares were issued at an average premium of 13.2% to the unaudited NAV per share at 30 June 2018, adjusted to exclude the dividend paid on 31 August 2018.

Debt

At the Period end the Company operated:

• A £35m revolving credit facility ("RCF") with Lloyds Bank plc, which attracts interest of 2.45% above three-month LIBOR and expires on 13 November 2020;
• A £20m term loan with Scottish Widows plc, which attracts interest fixed at 3.935% and is repayable on 13 August 2025;
• A £45m term loan with Scottish Widows plc which attracts interest fixed at 2.987% and is repayable on 5 June 2028; and

• A £50m term loan with Aviva Investors Real Estate Finance comprising:

i)        A £35m tranche repayable on 6 April 2032, attracting fixed annual interest of 3.02%; and

ii)       A £15m tranche repayable on 3 November 2032 attracting fixed annual interest of 3.26%.

Dividends

An interim dividend of 1.6375p per share for the quarter ended 30 June 2018 was paid on 31 August 2018.  The Board has approved an interim dividend relating to the Period of 1.6375p per share payable on 30 November 2018 to shareholders on the register on 26 October 2018.

In the absence of unforeseen circumstances, the Board intends to pay quarterly dividends to achieve a target dividend12 per share for the year ending 31 March 2019 of 6.55p (2018: 6.45p).  The Board's objective is to grow the dividend on a sustainable basis, at a rate which is fully covered by projected net rental income and does not inhibit the flexibility of the Company's investment strategy.

12 This is a target only and not a profit forecast.  There can be no assurance that the target can or will be met and it should not be taken as an indication of the Company's expected or actual future results.  Accordingly, shareholders or potential investors in the Company should not place any reliance on this target in deciding whether or not to invest in the Company or assume that the Company will make any distributions at all and should decide for themselves whether or not the target dividend yield is reasonable or achievable.

- Ends -

Further information:

Further information regarding the Company can be found at the Company's website www.custodianreit.com or please contact:

Notes to Editors

Custodian REIT plc is a UK real estate investment trust, which listed on the main market of the London Stock Exchange on 26 March 2014.  Its portfolio comprises properties predominantly let to institutional grade tenants on long leases throughout the UK and is principally characterised by properties with individual values of less than £10 million at acquisition. 

The Company offers investors the opportunity to access a diversified portfolio of UK commercial real estate through a closed-ended fund.  By targeting sub £10 million lot-size, regional properties, the Company intends to provide investors with an attractive level of income with the potential for capital growth. 

Custodian Capital Limited is the discretionary investment manager of the Company. 

For more information visit www.custodianreit.com and www.custodiancapital.com.