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James Carthew: I spy bargains in student & social housing

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James Carthew: I spy bargains in student & social housing

Events are moving so fast that it is hard to find much that is concrete to build an investment case around. This is especially true when pronouncements from governments can radically alter assumptions in an instant. 

Casting around for potential bargains, I thought it might be worth looking at the AIC’s Property – UK Residential sector. It contains trusts trading at fairly chunky discounts and high yields, whose fortunes ought to be relatively simple to predict.

Until their modest rally this week GCP Student Living (DIGS) and Empiric Student Property (ESP) had both halved in value in the coronavirus sell-off. Ahead of the outbreak of Covid-19 I had been thinking about cashing in my gains on ESP’s recovery from a dividend cut two years ago. The shares, which I bought for about 83p back in 2017, had clawed their way back to £1 as the management team cut costs and the vacancy level. The dividend yield was still quite attractive, however and so I decided to hang on.

Today, universities are halting face-to-face classes and shifting to online exams and assessments. That does not mean that students have to vacate their apartments, however. For the companies, rental income for the current academic year should be guaranteed – Scape, for example, requires students to find someone else to take on the let if they want to get out of the contract, otherwise they are on the hook for the whole year’s rent.

Rival Unite (UTG) has bitten the bullet and allowed students to break their contracts leading to its decision to cut dividends yesterday.

We don’t yet know whether things will have settled down by the summer. This could put a small question mark over those halls of residence that top up their income with summer lets, but this is negligible as far as DIGS and ESP are concerned. 

The real conundrum is whether they will be able to fill the accommodation again for the next academic year. We may see fewer international students coming to the UK. If everything else seemed to be returning to normal during the summer, any shortfall in demand from international students might be made up from domestic ones. 

If online learning looked set to continue for much of the next academic year, much of the accommodation might sit empty. However, in the following academic year, I would expect a return to close to a zero vacancy level.

In a worse-case scenario then, these real estate investment trusts (Reits) might have to suspend dividends for a year as well. I do not think their debt poses too big a threat. DIGS had a loan-to-value ratio of just 19% at the end of December 2019, ESP was higher at 32.9%. It seems likely that the government will lean on banks not to enforce covenants. So, on a two-year view, perhaps we could see these share prices doubling from current levels.

The share prices of the social housing funds, Civitas Social Housing (CSH) and Triple Point Social Housing Reit (SOHO), were creeping back towards premium territory at the start of the year. Now both sit on substantial discounts of 16% and attractive yields of 6%. This is puzzling because both trusts have some of the most predictable revenues of any I can think. 

To revisit the investment case which I made a year ago about SOHO, people with special needs need specialist accommodation adapted to their requirements. CSH and SOHO provide this and their rents are paid by local authorities using funds provided by central government. Demand for the properties exceeds supply and much of the rental income rises with inflation. 

Civitas had one small problem with a housing association renting its properties back in 2018 that cost it about £300,000. This compares to a rent roll of £46.5m at the end of September 2019, which is higher today.

Residential Secure Income Reit (RESI) should be celebrating as it has just secured access to government grants that will help it expand its portfolio. Its shares also fell heavily in the pandemic scare and even after rallying with the recovery in markets and investor sentiment this week remain on an 18% discount. 

Its portfolio is a mix of shared ownership homes, local authority accommodation designed to alleviate the problem of homelessness and retirement rental housing. Its revenues are not as secure as those of CSH and SOHO, but in normal circumstances are still fairly predictable.

Lastly, PRS Reit (PRSR), which at the end of December owned 1,617 completed homes and was developing 3,300 more, offers the highest yield of the lot – nearly 8% and stands on a 31% discount. There is little doubt that there is demand for PRSR’s homes, occupancy was 98% at the end of December. I suppose there could be a question mark over affordability if large swathes of the population are unable to work. 

The government has promised that nobody will be evicted as a result of not being able to pay rent for at least three months. Landlords have been promised mortgage payment holidays on properties where tenants are experiencing financial difficulties but this seems to be aimed at buy-to-let mortgage holders. It seems sensible that PRSR should be entitled to some government help if its tenants are struggling.

The perceived problem with PRSR might be that it has relatively high levels of debt. Again though, given the mood music, it seems likely that a short-term breach of any of its debt covenants would be forgiven.

It seems to me that there might be some bargains in this corner of the market. Which, if any, you go for will depend on your risk appetite.

James Carthew is a director at Marten & Co. The views expressed in this article are his and do not constitute investment advice.

 

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