Posted on 23 Aug 2017

Palace lords the planners


Earlier this month, I suggested it was a pretty good time to buy the Aim-traded shares of property investment company Palace Capital (PCA:395p) ('High-yielding opportunities', 8 Aug 2017), noting that success on the planning front was a likely catalyst for a higher rating.

Bearing this in mind, the company has just announced that the planners have given their consent for the redevelopment of Hudson House in York, a 103,000 sq ft office block located close to the city’s railway station, into 127 apartments covering 95,000 sq ft, 34,000 sq ft of offices, 5,000 sq ft of retail space and car parking. The sales market in the York and Harrogate area is buoyant as buyers move from the outskirts to the town centres, so it shouldn’t be difficult to find buyers for the units as has been the case with the nearby Terry’s Chocolate Factory in York. This property has been converted into residential by another favourite company of mine, property investment and construction company Henry Boot (BOOT:301p). Interestingly, Henry Boot reports interim results this Friday, so expect a further update on how sales in York are progressing.

The directors of Palace Capital believe that the Hudson House scheme will cost around £35m to develop which gives a total cost of the project of £50m after accounting for the £14.9m carrying value of the site in the company’s accounts, albeit it’s already showing a hefty profit as it was acquired for only £3.8m as part of the Signal Portfolio acquisition from Quintain in 2013. To put the potential redevelopment profit upside into some perspective, property analyst Tim Dainton at brokerage Arden Partners believes the value of the scheme “will be no less than £60m, but this could prove conservative given the proximity of Hudson House to the railway station and less than a two hour journey to London.”

He notes that apartments in a similar sized scheme in Harrogate achieved valuations of around £650 per sq ft, and though it’s difficult to quantify the exact prices the Hudson House scheme will achieve, if the units went for a similar price per sq ft then the implication is that the residential element could achieve the £60m sale values by itself. Moreover, although there has been no new office space in York for the past 20 years, and “while it’s difficult to prove that rents are higher than £18 per sq ft”, brand new office space in Leeds is going for around £30 per sq ft, according to Mr Dainton. This leads me to believe that a valuation for the office space could be anything between £10m to £14m based on an annual rent roll between £600,000 to £1m to a quality tenant.

So, although analysts at both Arden and Edison Investment Research have held their full-year net asset value estimates at 445p and 449p, respectively, I would be very surprised if we don’t see a decent valuation uplift on this development when the company reports its interim results later this year. I would also point out that the Hudson House development is unencumbered, so the directors have the flexibility of either putting it into a joint venture if a partner can be found, or alternatively redevelop the scheme themselves using Palace Capital’s lowly geared balance sheet. Either way, there is upside potential here for a company which had a last reported net asset value of £110m.

Ahead of the first half results to end September 2017 which will be announced in November, I continue to rate shares in Palace Capital attractively. Please note that I initiated coverage last autumn at 335p ('A royal investment', 17 Oct 2016), since when the board has declared dividends of 18.5p a share for the 2016/17 financial year, with prospects for a 19p a share payout this year, according to analysts from both firms. Trading on a 12 per cent discount to conservative looking net asset value estimates, and offering a solid looking 4.8 per cent prospective dividend yield, I continue to rate the shares a buy.

Source: Investors Chronicle