Posted on 23 Jan 2014

Ride the Property Rebound


Service companies offer a good way to play the real estate recovery

Real estate’s time has come once again. The industry was one of the hardest hit when banks withdrew their support following 2007’s financial crisis and many companies only survived the double-dip recession that followed through assets sales and by the support of their shareholders. The industry is making headlines again, but this time for the right reasons.

Growth in the property market has outstripped inflation in the past year, with the residential sector taking centre stage. House prices grew on average 5.4% in the 12 months to November, according to the Office for National Statistics (ONS). However, in London the rise in asking prices was more than double the national average, increasing 11.6% over the period.

Such growth is being fuelled by banks easing their purse strings. In November £10.3 billion worth of mortgages were approved, 37% higher than home-buyers’ received 12 months earlier, according to the British Bankers’ Association. Banks have regained their bullish stance on the residential market thanks to Government initiatives such as Funding for Lending, which has offered them cheap cash since August 2012 to fund their personal and small business lending. Then there is Help to Buy, where interest-free loans are provided to home-buyers for up to 20% of the value of a property worth £600,000. Despite the Government scaling back Funding for Lending for house-hunters, valuations have continued to rise.

Buying the sellers

There are several options for investors wanting to play this growing market. Estate agency and property services group Countrywide (CWD), which re-joined the stock market last March after a six-year absence, has more than 1,300 offices throughout the UK. It continued to expand this network in 2013 by spending £23.9 million on adding 28 lettings businesses to its portfolio.

The group, which includes Hamptons and Churchills among its brands, trades at a slight premium to the market on a prospective multiple of 16.2-times forecast earnings, which is justified by the size of its growing national network. Another growing network is owned by Belvoir Lettings (BLV:AIM). The franchiser raised £6.2 million at its Aim debut in February 2012 to expand its reach, especially in London and the South East. Its aim is to take advantage of the growing rental market where it estimates 60% of such properties are managed by agents on behalf of private landlords.

In the first half of 2013 Belvoir added 13 new outlets bringing its portfolio to 155, and made two acquisitions. It has even started a pilot scheme to add house sales to its offering to meet demand. It trades on a prospective price/earnings (PE) ratio of 15.3, falling to 12.8 times in 2015, according to consensus, and is slated to make total distributions of 8.9p in 2014, equivalent to a juicy 4.9% yield.

Other plays on the residential market include Grainger (GRI), the UK’s largest quoted residential landlord, which offers exiting growth potential. Numis forecasts net asset value (NAV) per share will increase by another 12% this year to 219p. Future growth drivers include its £150 million construction pipeline that includes 100 flats in Barking, London, which are expected to yield more than 8% for the business.

The majority of Grainger’s assets (60%) are in the high growth markets of London and the South East and it owns a substantial portfolio of German assets. In addition the company manages £2.8 billion of rental property for third parties and owns an equity-release business targeting retired householders.

You might not agree with Bank of England governor Mark Carney that the housing market is making up for years spent in the doldrums and be of the view that  fundamentals have got to intervene at some point as affordability considerations begin to bite. If this is the case then the London market might hold appeal given its own unique set of drivers, and this leads to the door of Foxtons (FOXT). The London-focused estate agency and letting business has more than 40 outlets in the capital, a market where demand continues to outstrip supply. This is thanks in part to a recovering financial services sector and demand from international buyers who have flocked to its bricks and mortar in search of safe-haven assets.

Foxtons joined London’s Main Market towards the end of September when the £55 million it raised was used to clear debt and provide the required funding to open five to 10 new branches a year until 2018. It has already got to work on this strategy, having opened new branches in Crystal Palace and Twickenham.

Foxtons, which is known for its motivated sales team, trades on a lofty prospective PE of 26.1, which reflects its growth potential. Indeed, in its first update since it went public, the firm revealed revenues of £41.1 million in the three months to October – a 17.9% rise year-on-year. Property sales grew 28.7% during the period, while lettings and mortgage revenues improved 8.7% and 63.6%, respectively.

Alternative markets

Signs that the real estate market has started on a new prolonged up cycle are not just boosting those with residential interests but firms serving niche spaces are doing well too. The student accommodation space is one such example. Rising enrolments in combination with under-supply of housing meant student accommodation generated a 7.8% average return in the year to September, with the asset class out-performing all other traditional commercial property segments, according to property consultancy Knight Frank.

Future growth could come from the industry’s huge development pipeline. Knight Frank estimates that there are some 13,000 student bedrooms planned or under construction in London, while Bath, Brighton and St Andrews are cities with the lowest supply of purpose-built residencies. Building properties pays dividends. Rents generated by purpose-built sites are up to 56% higher than those from converted house shares in London.

Today’s students have to pay thousands of pounds to study in higher education and they want access to better quality housing and Unite (UTG) is a company building and managing such properties. The group bought a site in Newcastle city centre (14 Jan) where it will build a 200,000-square foot property by 2016 to house some 600 students. It is holding negotiations for three further sites, highlighting its determination to meet demand across the country, which is set to rise beyond 2015 after the Government abolishes the cap on the number of the country’s university places. Unite currently has 98% occupancy across its 130 properties and expects rental growth to reach 3% this year.

 

 

Developer Terrace Hill (THG:AIM) also has an element of student housing in its portfolio. However, the company has transformed its strategy in the past year and it approaches 2014 with a clearer focus, lower debt and a vibrant pipeline. A restructuring programme has put the £51.4 million cap on a stronger footing as the market picks up. It disposed of almost 1,000 residential properties for £70.8 million to greatly reduce financial gearing. The firm is now focused on commercial property, especially in the development of food stores. It is intending to build supermarkets in Stokesley, Herne Bay and Middlesbrough.

The portfolio also contains offices and warehousing and last month (19 Dec) Terrace Hill secured permission to build a £30 million leisure complex in Darlington, which includes a nine-screen cinema, 80-bedroom hotel and six restaurants. Despite trading at a premium to NAV, the prospective PE of 6.2 is too low and the proposal to reinstate the dividend after a five-year absence should spark investor interest.

Regeneration specialist St Modwen Properties (SMP) is another company with a strong pipeline. It specialises in regenerating brownfield land and has more than 100 active sites around the UK. These projects include the £2 billion New Covent Garden Market property in Nine Elms, London, a new campus for Swansea University and the on-going transformation of the former Longbridge car plant in Birmingham.

 

St Modwen builds whatever it sees a demand for on its land, which has included housing, hotels, warehousing, schools, retail and leisure developments. In last month’s trading update (4 Dec ‘13), the company announced that its pre-tax profits for the year to December would be substantially ahead of expectations.

Also with huge projects under-development is European property investor CLS (CLI). The company has a 143,000 square metre mixed-use regeneration project in Vauxhall, South London, in the pipeline, which will be at the centre of the borough’s wider re-development. It is also working on improving the quality of its portfolio. One example was last year’s acquisition (16 Sept ‘13) of 34 properties for £118.6 million which are occupied mainly by secure Government agencies.

These strategies served the company well in 2013 when it enjoyed a near-70% share price rise breaking through the £10 barrier for the first time. So it is all the more shocking that chief executive officer (CEO) Richard Tice quit earlier this month (13 Jan) after almost four years in the role. However, majority shareholder and executive chairman Sten Mortstedt is likely to pick a boss in the same mould as Tice, who leaves his charge in good nick. It trades on a prospective PE 13.9, which is expected to fall to 11.4 times in 2015.

Another niche in the real estate market is self-storage with Lok’n Store (LOK:AIM) a key player in the South East. The firm declared a much-better-than-expected full-year dividend of 6p at November’s finals (14 Oct ’13), highlighting management’s confidence in the business.

And the business still looks cheap trading at a sizeable 21.3% discount to the latest NAV per share figure of  248p as at the 31 July 2013 financial year end.  The firm is expanding its estate through new openings and developments to meet under supply in the market. Indeed, it bought a site in Bristol where it will build a 50,000 square foot facility, which will take its number of outlets to at least 26 by the end of the year.

 

 

Second time around

Returns from secondary commercial assets, characterised by properties situated outside of prime city locations and usually let on short-term leases, are expected to out-perform those generated by the prime market this year. While yields on primary assets have recovered since the crisis, the secondary market took the brunt of the downturn. Its yields have fallen 17% since the second quarter of 2008 due to a lower risk appetite among investors and a scarcity of debt funding.

But such assets are expected to yield 7.4% this year, rising to 10.3% in 2015, according to real estate services company DTZ, which names offices as the star performer in this sector ahead of retail and industrial. A good play on this trend is commercial property investor Palace Capital (PCA:AIM) which expects to pay 12p of dividends next year, equivalent to a juicy yield approaching 5%, as it capitalises on the high returns now on offer in its chosen sectors.

The £31.8 million cap has £45 million worth of assets after it bought a portfolio of 24 secondary properties spread across the UK, generating £5.2 million rent, equivalent to an attractive 13.2% yield. The acquired portfolio covers 1.1 million square feet and is predominately based in city-centre locations. Some 74% is freehold and the sites are let to 84 tenants on 95 leases, averaging 6.4 years to expiry, with a break at 3.8 years. Palace is led by CEO Neil Sinclair, an industry veteran of more than 50 years, who believes he can take these yields higher with improved asset management.

Palace is one stock that proves real estate is back in fashion and with such a diversity of assets to explore there are many avenues investors can take if they want to gain exposure to the recovering real estate markets.