Press coverage of the office property market focuses on eye-catching new-builds. But the main market is “secondary”: the purchase, refurbishment, re-letting and management of existing buildings. This is the focus of real estate investment trust Regional Reit (LSE: RGL). It floated four years ago.
RGL’s commitment to a progressive 8% yield plus a bit of capital return was treated with scepticism at first but the target for this year, 8.25p a share, is 8% ahead of the initial dividend. The total return of 10% per annum since launch makes its performance among the best in the sector. This impressive record has facilitated two fundraisings and resulted in a company with a £450m market value and £720m of assets.
Some of that success is the result of a strong in-house team, resulting in intensive management of properties, tenants and debt. There has also been a shrewd evolution of the portfolio, with the office component rising from 58% at launch to 78% .
Eyeing up regional offices
The best opportunities, chief executive Stephen Inglis believes, are in offices, where capital values of £129 per square foot compare with replacement cost of £185-£220. Rental growth of 5.2% in the first half of 2019 from 39 new lettings was most marked in the office portfolio, where RGL is seeing growth for the first time in 12 years. Moreover, returns since 2016 have been higher in regional cities, where RGL invests, than in London and Inglis expects that to continue. Supply of office space in the regions is at a 12-year low.
Despite strong tenant demand and higher rents, RGL is finding a ready supply of high-quality opportunities from forced sellers. Inglis is convinced that in time “capital will be attracted back into regional offices, with rates of return for investors of 15% easily achievable”. Meanwhile, RGL has a £500m pipeline of opportunities. £20m was invested in the first half and a further £26m recently. In current market conditions and with rents rising, sales are unusual, although a Sheffield property was sold for a 25% profit in the first half.
To enhance the investment return, the portfolio is financed by debt up to a limit of 40% of value. With secured debt of £292m at an average cost of 3.5% fixed for eight years, RGL is bumping against its ceiling and there is also a £50m unsecured bond issue. The loan covenants look secure, though the pipeline of opportunities suggests further equity issuance, which makes it hard to see the 9% discount of the share price to net asset value narrowing much.
Despite this, the record, strategy and prospects for RGL in its core market, with rents rising and values depressed, make it an attractive investment.