Posted on 06 Mar 2014

Secondary Home for Yield


The total return offered by secondary properties, located in the country’s regional towns and small cities, is set to outperform those generated by prime assets in the UK’s major metropolitan areas, according to property services specialist DTZ. To play this trend we flag Palace Capital (PCA:AIM) although we don’t rule out prime plays entirely and believe British Land (BLND) should be considered for its exciting London development projects.

Since the financial crisis erupted in 2007 appetite for risky properly plays has diminished, especially among the banks which have adopted a more cautious stance with their cash. This has resulted in a weaker secondary market in recent years. Secondary real estate is more sensitive to the general economic backcloth, so when UK plc is in recovery mode it outperforms prime assets. But, as seen in the past few years, it underperforms during periods of weakness.

Rents in the secondary market have fallen 17.4% since their peak in the second quarter of 2009, while prime rents from long leases have proved defensive as the economy has struggled. Improving economic conditions and increased investor appetite is altering the yield spread – the gap between prime and secondary yields. But there is more to play for and investors can still find value in the secondary market which will produce a 12.1% total return this year, eclipsing the 10.1% from prime commercial property, forecasts DTZ. In 2013 secondary commercial property generated a 5.1% return and prime 8.6%.

Prime is supported by a lack of new developments, while oversupply in the secondary market makes it vulnerable in periods of economic strife. While we have focussed in turn on a secondary and a primary property market specialist for this piece Helical Bar (HLCL) enjoys the best of both worlds, using secondary assets to fund its prime portfolio (see Griller, Shares 27 Feb). The £431 million cap has bought a range of shopping malls around the country, which provides the income to pay the interest on its loans and its dividends while it works on its development pipeline, including a £150 million regeneration scheme in Hammersmith, London.


Palace Capital (PCA:AIM) 250.0p

 

Commercial real estate investor Palace Capital’s (PCA:AIM) timing couldn’t be better. The company focuses on secondary properties, typically outside London, and bought a portfolio of 24 assets across the country last winter (21 Oct ‘13) just before the rest of the market really latched onto the UK recovery story.

The acquisition is part of the firm’s strategy to target sites yielding at least 11% and dividends are forecast by house broker Arden Partners to triple in 2015 to 12p from this year’s expected 4p payout. Almost half of the portfolio (48%) is offices, mostly in city-centre locations, industrial makes up 34% and retail and parking accounts for 10% of the book.

Palace paid £39 million for the 24 properties acquired from developer Quintain Estates & Development (QED) and by March they were valued at £42.4 million. Rent from the acquired assets comes to £5.2 million, equivalent to an attractive 13.2% yield. Palace is led by CEO Neil Sinclair, an industry veteran of more than 50 years’ experience, who believes improved asset management can take the yield higher still.

The deal transformed the group from one with a market cap of £800,000 and nine properties in Cheshire to a business with more than 30 assets worth some £31 million. Palace has not rested on its laurels since the deal and has remained active in a drive to efficiently manage its portfolio. Last month (19 Feb) it disposed of its freehold interest in Gelderd Point, a vacant office block in Leeds. The property was sold to a Lincolnshire company for some £1 million cash, which after costs represented a 13% premium to book value.

This followed December’s sale of another vacant office unit when the company collected £800,000 for a property in Tolworth, Surrey, on which it generated a £285,000 profit. These and other deals have reduced net debt which currently stands at a manageable £17.8 million. At 250p Palace trades at only a slim 8% premium to Arden Partners’ forecast 232p net asset value for the 31 January year end.

Growth: HIGH

Palace created a UK secondary property portfolio just ahead of a pick up in the economy. As the recovery gathers pace the company’s portfolio should enjoy a good valuation uplift.

Risk: LOW

While there is much talk that the country’s economic rebound has been built on loose credit and a property market bubble we don’t buy that argument in which case the value of Palace’s portfolio should prove stable.

Quality:  HIGH

 

Palace has a well-diversified book which stretches right across the UK. Meanwhile its buying and selling activities are actions of a management tirelessly working at improving the portfolio’s quality.

 

 

 

 

An improving economy puts prime property in the shade.

The total return offered by secondary properties, located in the country’s regional towns and small cities, is set to outperform those generated by prime assets in the UK’s major metropolitan areas, according to property services specialist DTZ. To play this trend we flag Palace Capital (PCA:AIM) although we don’t rule out prime plays entirely and believe British Land (BLND) should be considered for its exciting London development projects.

Since the financial crisis erupted in 2007 appetite for risky properly plays has diminished, especially among the banks which have adopted a more cautious stance with their cash. This has resulted in a weaker secondary market in recent years. Secondary real estate is more sensitive to the general economic backcloth, so when UK plc is in recovery mode it outperforms prime assets. But, as seen in the past few years, it underperforms during periods of weakness.

Rents in the secondary market have fallen 17.4% since their peak in the second quarter of 2009, while prime rents from long leases have proved defensive as the economy has struggled. Improving economic conditions and increased investor appetite is altering the yield spread – the gap between prime and secondary yields. But there is more to play for and investors can still find value in the secondary market which will produce a 12.1% total return this year, eclipsing the 10.1% from prime commercial property, forecasts DTZ. In 2013 secondary commercial property generated a 5.1% return and prime 8.6%.

Prime is supported by a lack of new developments, while oversupply in the secondary market makes it vulnerable in periods of economic strife. While we have focussed in turn on a secondary and a primary property market specialist for this piece Helical Bar (HLCL) enjoys the best of both worlds, using secondary assets to fund its prime portfolio (see Griller, Shares 27 Feb). The £431 million cap has bought a range of shopping malls around the country, which provides the income to pay the interest on its loans and its dividends while it works on its development pipeline, including a £150 million regeneration scheme in Hammersmith, London.


Palace Capital 
(PCA:AIM) 250.0p

Commercial real estate investor Palace Capital’s (PCA:AIM) timing couldn’t be better. The company focuses on secondary properties, typically outside London, and bought a portfolio of 24 assets across the country last winter (21 Oct ‘13) just before the rest of the market really latched onto the UK recovery story.