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Trust Insider: is deep discount European property worth a punt?

Trust Insider: is deep discount European property worth a punt?

I promised this week I would look at some of the Eastern European property funds. Like the private equity companies I examined last week, these were almost entirely launched in the boom times of 2005-07 and suffered in the downturn that followed.

Some of these are so tiny that they are not worth dwelling on – funds such as Pactolus Hungary and Black Sea Property have been selling off assets and returning the proceeds to shareholders for some time.

But there are some real heavyweight funds focused on the area as well. Raven Russia (warehouses in Russia) has a market cap of £549 million and is trading on a 3.6% discount; Dolphin Capital Investors (specialising in beachfront land in Croatia, Greece, Cyprus and Turkey plus some off-topic exposure to Panama and the Dominican Republic) has a market cap of £238 million but still trades on a 50% discount. Mirland Development Corp holds a mix of residential and commercial real estate in Russia and seems to be trading on a substantial premium.

This week I will focus on two Ukrainian property funds, Dragon Ukrainian (DU) and Secure Property Development (SPD). These have market caps of £33 million and £18 million. I have no idea how the political situation will pan out but, superficially, these funds are attractively valued. They are trading on discounts of around 66% and 42% respectively

DU raised about $300 million (£175.5 million) from investors in 2007. It bought a substantial quantity of property but was blessed with cash in the downturn rather than being leveraged into it, and it repurchased a large proportion of its share capital at a discount. The Ukrainian economy let them down though, it was severely affected by the crisis and this hurt the net asset value (NAV).

DU adopted a realisation strategy in February. Its portfolio is based around Kiev and the western part of Ukraine, apart from one investment held through its 12.5% holding in AIM-quoted Arricano Real Estate, a shopping mall in Simferopol in Crimea. Arricano’s share price does not seem to have been affected by recent events, but there has not been much trading in it.

The investment case for DU was that there was a lack of decent quality property in Ukraine and that, as the economy grew, upward pressure on rents and yield compression would generate decent returns for shareholders. It invested in high-end residential developments around Kiev, which are gradually being built out and sold off.

DU also plans to build a residential tower in Obolon in Kiev. This has been delayed by the economic situation but has now secured local funding and it has commenced pre-sales of apartments.

The other focus of the portfolio is on retail property. It holds a series of shopping centres. Partly through its investments in Arricano and, until recently, a stake in another retail developer, Henryland, cash is flowing back to DU from this investment.

DU also acquired a substantial land bank of 600 hectares around Kiev that it hoped would be rezoned for residential and commercial development. The land bank has lost considerable value over time as development work has been curtailed. DU is experimenting with selling part of it to private individuals.

Contrarian play

As a long-term contrarian investment, DU might be quite interesting. I think the political and economic situation will have to settle down before it can make any meaningful disposals and the price of Arricano might fall sharply if there was any selling pressure. However, I think, the £33 million market cap seems at odds with its existing cash balances – although, to be fair, DU says it wants to retain some cash to keep its options open in case the existing portfolio needs further investment before it is realisable.

What might put some people off is the incentive structure DU adopted when it implemented its realisation strategy. Under this the manager gets $9.2 million in management fees spread over the period from January 2014 and December 2018 and front-end loaded plus 3.5% of the first $50 million returned to shareholders, 7% on the next $25 million and 10% on the rest (these threshold figures are adjusted upwards if the NAV rises and over time) and the directors get 0.35% of cash returns. This looks pretty generous to me, and you would have to factor this in if you were thinking about investing in the fund.

SPD’s largest investment is a 50,000 square metre logistics park outside Kiev, Terminal Brovary.

It also owns a 22-hectare site that it intends to build a logistics park on outside Odessa, and a plot of land in Kiev for residential development with planning for 40 units – all well away from the current trouble – plus a 26-hectare site in Balabino. This is in the east of the country on the main road to Simferopol in Crimea. Development works might be held up by the political situation, therefore.

SPD intends to expand and branch out into Romanian and Bulgarian property. It believes there is money to be made by acquiring property in markets that have been hit quite badly by the credit crunch. That process has begun and it has just completed the acquisition of a logistics park outside Bucharest using funds it raised from investors in 2012.

There is a pure play on Romanian property however, Globalworth Real Estate. It has a market cap of £240 million, is trading on a discount of about 18% and is focused on commercial property in and around Romania. I’ll look at it next week.

Globalworth stands out because it is a relatively recent fund, listing in July 2013.

James Carthew is a director at Marten & Co

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