A cloud still hangs over the likes of Land Securities (LAND) and British Land (BLND), whilst Intu Properties (INTU), the shopping centre specialist, is hitting new multi-year lows. However, there is a clear distinction between these older, self-managed real estate investment trusts (Reits) and the newer, externally managed Reits. The wobble that hit the property sector in the wake of the EU referendum seems to have been shrugged off by the newer funds. They are not quite at their share price peaks but many are not far off. One of these is Custodian Reit (CREI).
Custodian listed in March 2014. It has a market value over £400 million and yields 5.6% in dividend income. The attractions of high income and liquidity have helped push its shares to a premium of nearly 12% above net asset value (NAV), making it the highest rated fund in the Association of Investment Companies’ Property Direct - UK sector (although many of the specialist healthcare related property funds trade on higher premiums).
Custodian is differentiated in that it has a policy of focusing on smaller properties (£2 million to £10 million) that would not normally interest institutional buyers. The beauty of this strategy, which has also been adopted by Reits such as Drum Income Plus (DRIP), is that the properties come on higher net initial yields – typically 1%-2% higher than equivalent institutional-sized properties. Drum goes further by embracing more multi-let properties that tend to come with even higher yields.
Custodian’s portfolio is pretty diversified. Its fact sheet includes a 3D pie-chart showing the split of income by tenant that emphasises this. B&Q, which accounts for 2.29% of the income, is the largest exposure and there were more than 275 tenants in the portfolio at 1 September.
The Reit is managed by a team led by Richard Shepherd-Cross of Custodian Capital, a subsidiary of Mattioli Woods, a pension consultant and wealth manager. They say they are looking for good quality properties with ‘robust’ tenants. Occupancy is pretty healthy, the void rate (the proportion of un-let properties) in the portfolio on 1 September 2017 was just 2.5%. By contrast, in the recent annual results of F&C UK Real Estate (FCRE), a portfolio with a void rate of 5.6% was described as ‘predominantly fully let’.
The target loan-to-value ratio (LTV), comparing the size of the debt with the value of the whole portfolio, is 25% and was 20.5% on 1 September 2017. In April 2017, the weighted average cost of its debt was 3.1%, giving them a very healthy margin on the properties they are buying. The weighted average maturity of this debt was over 10 years and, crucially perhaps given renewed talk of interest rate rises in the UK, 77% of it was at fixed interest rates.
The managers have been selling the odd property recently and booking profits, demonstrating that they are adding value to the portfolio.
The dividend target for 2018 is 6.45p per share. The quarterly payments have been covered by EPRA earnings per share since launch which enables the fund to build a revenue reserve. (The EPS figure is calculated according to European Public Real Estate standards that represents the net revenue and excludes capital profits and losses). Again, there is a contrast here between Custodian and a number of other property funds. Using the example of F&C UK Real Estate again, its dividend cover, the ratio of dividends to revenue earnings, was 0.944 for the year to the end of June 2017, up from 0.917 for the previous year.
Custodian had a head start on launch as it already had a £95 million portfolio and many happy investors, clients of Mattioli Woods. The pre-existing fund was rolled into the new listed vehicle and £55 million was raised from new investors. Since then, the company has expanded by raising additional capital on a number of occasions, most recently via small ’tap’ issues at a premium to NAV which enhances the holdings of existing investors.
In June this year, the board negotiated reductions from the fund manager in the administrative fee and a lower property management charge on assets over £500 million from 0.75% to 0.65% of NAV, anticipating a further expansion of the fund.
Custodian’s premium is high relative to its recent history, given it was about 2% in July. The board believes that there is ample scope for the company to continue to expand in response to investor demand. One question mark is how the fund would fare in a recession. The diversity of their tenant base should be a strength. In addition, the managers are busy working to extend the weighted average unexpired lease term of the portfolio. There could also be some comfort in that valuations in their part of the market have lagged those of places like London, which may be more exposed to a downturn.
James Carthew is a director at Marten & Co. The views expressed in this article are his and do not constitute investment advice.