Residential Secure Income

Transcription

1 Residential Secure Income is a client of Kepler Trust Intelligence. Material produced by Kepler Trust Intelligence should be considered as factual information only and not an indication as to the desirability or appropriateness of investing in the Residential Secure Income Update 26 November 2018 Summary Residential Secure Income (ReSI) is a REIT that, when fully invested, aims to generate an RPI-linked 5% dividend yield and capital growth from investments in the social sector. The trust takes a cautious approach which means it only invests in a project when it knows it can raise investment grade debt against the assets. This and the collapse of a few expected deals shortly after launch in July 2017 mean that the trust is not yet fully invested it is at 240m in gross assets which will rise to around 330m when the listing proceeds are fully invested and geared. This slow pace of investment has caused the trust to slip onto a discount relative to NAV and peers. The trust can invest in various residential sub-sectors, but concentrates on retirement, shared ownership, as well as leasing to local authorities for the vulnerable. The management team at TradeRisks, led by Ben Fry, view these types of assets as the more secure sources of income in the sector. Although the trust is not yet fully invested, it currently offers a prospective yield of 5.4% should current forecasts be met. The unleveraged yield on the underlying portfolio is 5%, in line with the long-term target. Dividends are paid quarterly. The trust is managed by a team at TradeRisks, which has raised debt and advised clients in the social sector for 17 years. The investment trust allows that team to plug a gap that of equity - in social financing which they have watched develop as government grants have reduced. Portfolio Residential Secured Income (ReSI) targets a 5% inflation-linked dividend yield and in excess of 8% total returns per annum from investments in social. Social is affordable accommodation and accommodation for vulnerable members of society or those with needs which the market struggles to meet provided by associations and local authorities. As the table below illustrates, there are many different aspects or sub-sectors within social. Analysts: William Heathcoat Amory +44 (0) Pascal Dowling +44 (0) Thomas McMahon, CFA +44 (0) William Sobczak +44 (0) Kepler Partners is not authorised to make recommendations to Retail Clients. This report is based on factual information only. The material contained on this site is factual and provided for general informational purposes only. It is not an invitation or inducement to buy, sell or subscribe to any product described, nor is it a statement as to the suitability or otherwise of any investments for any person. The material on this site does not constitute a financial promotion within the meaning of the FCA rules or the financial promotions order. Persons wishing to invest in any of the securities discussed in the website should take their own independent advice with regard to the suitability of such investments and the tax consequences of such investment. ReSI was launched in July 2017 after raising 180m of equity, and aims to leverage its property investments to 50% by issuing investment grade debt against those properties. The requirement for a high credit rating typifies the safety-first approach of the managers, led by Ben Fry. Ben concentrates on what he considers the lowerrisk projects in the sector. He does this by investing in accordance with three themes: properties with sticky tenants, those where the tenants pay below market rent, and those which are leased to a Local Authority (LA) or another body with a statutory duty to provide. 1

2 The Social Housing Sector RENTAL HOUSING Sectors SHARED OWNERSHIP Market rental Functional Focus for ReSI Purpose Benefits to investors Source: TradeRisks Shared ownership Allow first time buyers onto property ladder Shared Ownership consists of c. 125 year leases paying rent increasing annually at RPI + 0.5%. Tenants have a strong incentive to pay rent given their ownership stake. Staircasing terminates rental income but returns capital with potential upside. Solutions to temporary and emergency accommodation Provides accommodation for those otherwise in temporary or emergency accommodation Leases are direct with local authorities who are generally AA rated entities, and have a statutory duty to house those who are homeless or threatened with homelessness ReSI rents around market rent to minimise downside risk if local authority doesn t renew lease Retirement rental / sheltered Provides a rental option with lifetime security of tenure for the elderly or those requiring specially adapted homes Rental payments are delinked to economy as tenants pay through pensions, benefits etc. Includes property used to house the property manager within the development they manage, with the rent ultimately paid by the service charge of all leaseholders providing a very secure income stream Sub-market rent Affordable and intermediate Subsidised rent for key workers and low income groups Properties let below market rent with high demand due to a shortage of other affordable options Sticky tenants include the retired, who are typically reluctant or unable to move, key workers such as nurses who need to be housed near to their place of work, or livein managers for such projects. As these groups are unlikely to move, the managers believe that the rental income is more secure. Below market rental rates are paid by key workers and low income groups (which may include those on benefit or universal credit), and includes social rents, with rents set based on local wages rather than market rent levels, and intermediate rents typically set at 80% of market rate by central government to be affordable to key workers and those on lower incomes. The managers see a constant stream of new potential projects in the below market rent bucket thanks to councils requiring developers to build social as part of new developments under the powers granted in section 106 of the Town and Country Planning Act The third theme involves investing in properties leased to local authorities to house tenants in immediate need of short term accommodation. This is exemplified by a deal the company has done with Luton Borough Council. Like all councils, Luton is required to offer for people who cannot find it elsewhere. Often this results in people put up in B&Bs or hotels in insecure and expensive accommodation. An alternative is ReSI s project in Wesley House, which is comprised of 134 units. Paying the rent on these flats is far cheaper for the council than putting the homeless up in hotels or B&Bs, as well as being a far better living situation for the tenant. ReSI paid 21m for the freehold in June 2018, and receives a CPI-linked, upwards only rent from the council with an average remaining term of 7.3 years. In July, RESI paid 13m for the 155-unit property Eaton Green Court in the same city and has leased it to the council for 9.2 years. In both cases the council bears the letting risk and repairs and upkeep are also the responsibility of someone other than the company. The yield for the two Luton transactions is in excess of 5%. Ben hopes to do more deals in this sector but notes that it is hard to get the councils to agree to leases over ten years. ReSI now has a strong relationship with Luton Borough Council which may lead to more business in the future given that city s needs it currently has 1,314 people living in temporary accommodation. Looking at the sub-sector breakdown of the portfolio as it stands today, around 77.5% of the invested portfolio Fig.1: Sub Sector Exposure Source: ReSI 2

3 is in retirement properties, with 15.4% in short term accommodation leased to LAs and 7.1% in shared ownership. There is c. 20m in cash on the balance sheet and roughly 60m to 70m of levered equity left to be invested, which means that retirement properties will make up over half the portfolio when the trust is fully invested. The manager expects to focus the remaining capacity predominately on shared ownership which has sticky tenants, who have an economic stake in the property, and are paying below market rents. The cautious approach to investment is one reason that the trust is yet to fully invest its IPO proceeds. Ben estimates that he has turned down over 3bn in potential deals as they did not meet his stringent criteria. The trust had expected to be full invested by April 2018, but three deals worth 250m fell through at a late stage in the first quarter. Two deals were placed on hold thanks to merger activity by the associations, while another delayed the implementation of their strategy after changes to the composition of their board. It has taken time to find alternative investments thanks to the high levels of security the manager requires. While this is obviously disappointing for shareholders, it demonstrates considerable discipline on the part of the managers and shows they are sticking to their guns. The shared ownership sector is a key area of interest to ReSI and following the collapse of the intended deals in Q1 it has taken an innovative step to refill its pipeline. In July 2018, authorisation was granted to a wholly-owned subsidiary, ReSI Housing, to operate as a registered provider of social. This means that it can purchase properties and repurpose them for social needs (such as shared ownership) rather than purchasing the properties from associations. On 25 October, the company announced the completion of its first such deal. ReSI bought 34 new build homes in Barnet from Crest Nicholson for 16.45m - and will hold them through ReSI Housing. The properties will be converted into shared ownership units, aimed at first time buyers with small deposits. Shared ownership structures have a number of features that sit well with the approach of the manager. In these schemes, first time buyers put down a small deposit and take out a mortgage on the remainder of a certain proportion of the total property value, typically 25%. The remainder is owned by the association or investor, and the first-time buyer pays a below market level of rent on it, typically linked to RPI plus 0.5%. Over time, the buyer purchases further increments in the property at market level, which for RESI results in an uplift in the value of its investment. Ben views this as an attractive sub-sector for future investment. Earlier in the same month the company bought a 39-unit portfolio of flats in retirement blocks which are used to house the property managers for the developments. The weighted average unexpired lease term is 114 years and the geared net yield above 5%, supporting, with leverage, the 5% dividend target. The management team are focused on deploying and gearing the 180m fully, but we understand there are more potential deals which appear to meet RESI s investment requirements, so future placings are not out of the question. We understand this pipeline focuses on private sector developers, where ReSI is looking to secure framework deals, and several associations, and well as further opportunities for local authority. The opportunity to access shared ownership from developers (both private and associations) utilises ReSI Housing, ReSI s for profit registered provider of social. Peer Group There are two other investment companies specialising in social investment, all launched in the past 18 months. Although the three trusts have very similar target yields and returns, ReSI is differentiated in terms the type of risk it is taking and sub-sector positioning. Social Housing Reits Target returns Target dividend Target leverage Focus RESI TRIPE POINT 8% 9% 8% 5% 5% 5% CIVITAS 50% 40% 30% Retirement / shared ownership / Local Authority Source: Investment companies Specialist supported Specialist supported Both Triple Point and Civitas have concentrated on specialist supported. This is adapted accommodation for those with special needs and is let at 1.5 to 2 times the market rent, reflecting its scarcity and the work involved to prepare it for its use. The benefit of this sub-sector is that the rent is ultimately paid by the state through and other benefits, via leases with small associations. In TradeRisks view, this leads to one of the key drawbacks, however. Rents are so high thanks to the scarcity of stock. Should this scarcity cease to be such an issue, rents could be driven down as there is ultimately only one customer in each geographic area, and rental payments follow the underlying resident not the building. 3

4 This issue is compounded by the two companies letting to small associations, most of who don t own homes but lease them, and therefore have very low levels of asset backing. They also have much shorter rental contracts with the local authorities than their lease obligations. This means that if the local authority cuts the rent they will have no recourse, and there are potential risks to solvency from the mis-match between the duration of assets and liabilities. The regulator is investigating some of these small associations following the failure of one, First Priority. ReSI, on the other hand, receives its income from more fundamentally secure sources: retirement homes, shared ownership and leasing to local authorities as solutions for emergency. It therefore focuses on rent levels which are at or, ideally, below market using strong counterparties to manage its stock. In the case of the retirement homes, the rent is paid from the pensions of the residents, topped up where necessary with benefit and so is not economically sensitive. Whilst ReSI is taking risks of voids and bad debts, ReSI copes with this by being highly selective with regards to investments and has extremely low bad debts on this portfolio. The company also owns a portfolio of management flats these are the apartments on the retirement developments retained for the use of the manager, and therefore backed by the revenues of that manager. ReSI s requirement that they can raise investment grade debt against the assets is unique in the sector, and further helps to ensure these investments are more secure. ReSI also uses a more conservative valuation framework. The Existing Use Value Social Housing model used by Triple Point and Civitas uses the rental value of the property in its current social use to give a capital value. However, as the portfolios are largely invested in specialist supported, the rental values are largely above market, so the capital values in the accounts are above market too. By contrast, ReSI focuses on rent levels being at or, ideally, below market and hence its valuation of assets is below their open market value. Gearing The company s strategy is to run with 50% gearing of gross assets when fully invested. This is achieved by gearing up each transaction by borrowing roughly 50% of the value of the deal secured against the assets (rather than the portfolio) with long term debt which matched the asset cashflows to minimise interest rate and refinancing risks. The company benefits from TradeRisks debt investor relationships and experience as a corporate finance specialist with a background working in this sector, which means that they can arrange favourable rates. In line with ReSI s pre-condition for any property acquisition, the debt taken on by the trust (but secured on specific assets) must all be assessed as an investment grade. The two existing debt transactions have been fixed-rate, and partly amortising, therefore neutralising half of the duration risk in the portfolio. Currently the trust has 93m of gearing paying an average interest rate of 3.47%. The debt has a headline maturity of 25-years, reducing the risk it will have to be refinanced at higher rates. Following October s transactions, we estimate that the portfolio is represented by 238m of property assets, 20m cash and 93m of debt with around 60m - 70m of gearing yet to be arranged and deployed. Returns Returns were strong in the first accounting period, from launch in July 2017 to the end of September ReSI returned 9.5% in NAV total returns, which includes three dividends of 0.75p (the fourth was announced outside the accounting period) and a 7.3% increase on opening NAV. This means that total returns are in line with the long-term objective of 8%+ p.a. The valuation uplift of 7.1p on opening NAV of 98p is a solid step forward. Much of the gain came from the extension of the leases on 1,003 retirement properties from an average of 72 years to 150 years, which was achieved with minimal net cost to the company. The value of the two tranches of retirement properties bought in May and September were also written up by the independent property valuer Savills, who judged that the acquisition price was highly advantageous. In the case of the May deal, ReSI was able to arrange this complex transaction thanks to their expertise and willingness to negotiate with three parties, while in the case of the September deal, RESI benefited from being a preferred purchaser thanks to its existing retirement portfolio. Clearly the lengthening of the leases cannot be repeated every year, although there are still some properties on Fig.2: Performance Since Launch % ReSI: Performance versus peers Oct '17 Jan '18 Apr '18 Jul '18 Oct '18 Residential Secure Income (NAV) Triple Point Social Housing REIT (NAV) Source: Morningstar Residential Secure Income (Price) Civitas Social Housing (NAV) Powered by Highcharts Cloud 4

5 which it may prove possible to do the same, but next year the income from the portfolio should help take up the slack. The expectation set at IPO, confirmed in the recent release of the first annual results, was for four quarterly dividends of 1.25p in the second financial year, and ReSI remains confident this and the total return target of 8%+ can be met. The share price has been hit by the de-rating of the discount in March following the postponement of three well-trailed shared ownership purchases that were in the company s investment pipeline. Dividend ReSI has always aimed to provide a 5p inflation-linked dividend for the financial year beginning October 2018 and has now met its target of announcing 3p a share for the first financial year, ending September The trust has so far paid three quarterly dividends of 0.75p and announced a fourth of 0.75p. The forward yield (based on the current share price) is 5.4%. authorities and one former head of debt capital markets at HSBC and at JPM. This is a relatively young market and ReSI is managed by a team with comprehensive experience of all its facets. Discount The trust launched at par but fell onto a discount of around 10% in the first quarter of This was following the postponement of three shared ownership deals, trailed at the time of the IPO, which left the company holding a lot of cash and may have knocked investors confidence in the management s ability to execute the strategy. The management team have rebuilt the pipeline. but ReSI now sits on a significant discount relative to its peers. The trust implemented a share buyback programme in Fig.3: Discount 20 Social Housing REITs: Discounts / Premiums The managers report that the invested portfolio is delivering an unleveraged net yield in excess of 5%, in line with expectations. The company s ability to fully cover the prospective dividend of 5p (or a yield of 5.4% on the current share price) is reliant on the managers executing on their investment pipeline in line with their business plan. % Jan '17 Jul '17 Jan '18 Jul '18 Management Source: Morningstar Residential Secure Income Civitas Social Housing Triple Point Social Housing Powered by Highcharts Cloud ReSI is a REIT that was launched on the London Stock Exchange in July 2017, and is managed by ReSI Capital Management Limited, part of the TradeRisks group. TradeRisks is a long-standing actor in the social sector, with 17 years experience providing and arranging debt financing in the sector. The REIT is designed to provide a source of equity funding to the sector, replacing the steadily declining availability of government grants. Investment manager Ben Fry is an accountant by training who has worked at TradeRisks since He sits on a fourman investment committee which is chaired by Jonathan Slater, one of TradeRisks founders, and includes Mark Rogers, CEO of the new registered social provider ReSI Housing, and Pete Redman, Managing Director of property. There is a team of 28 people, including the investment committee, at TradeRisks / ReSI Capital Management led by Alex Pilato, TradeRisks group chief executive, former head of JP Morgan s risk advisory. Both Mark Rodgers and Pete Redman are former CEOs of major providers, while the board of four comprises three members with experience within providers or local April following the discount widening in March and has since repurchased 9.3 million shares at an average price of 92.5p. These purchases at a discount to NAV have generated accretion in NAV per share estimated at 0.7p, but the discount remains wide in absolute terms. Charges The ongoing expenses were 1.5% annualised from admission in July 2017 to September This was slightly higher than expected due to the costs of setting up and registering the subsidiary RESI Housing Ltd, which due to the additional structural costs involved with ReSI Housing, the manager expects the expense ratio to project at 1.5%, but decline as the fund grows. The management fee is 1% on the first 250m of NAV. Should the trust grow above 250m, 0.9% will be charged up to 500m and 0.8% up to 1bn. This is the same tiered set of charges made by Civitas and Triple Point. The AIC puts Triple Point s expense ratio at 1.36% and Civitas at 1.78%. Of the management fee, 75% is paid in cash and 25% in shares, which aligns the interests of the fund manager and shareholders. 5

6 Important Information Kepler Partners is not authorised to market products or make recommendations to Retail Clients. This report has been issued by Kepler Partners LLP, is based on factual information only, is solely for information purposes only and any views contained in it must not be construed as investment or tax advice or a recommendation to buy, sell or take any action in relation to any investment. If you are unclear about any of the information on this website or its suitability for you, please contact your financial or tax adviser, or an independent financial or tax adviser before making any investment or financial decisions. The information provided on this website is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation or which would subject Kepler Partners LLP to any registration requirement within such jurisdiction or country. Persons who access this information are required to inform themselves and to comply with any such restrictions. In particular, this website is exclusively for non-us Persons. The information in this website is not for distribution to and does not constitute an offer to sell or the solicitation of any offer to buy any securities in the United States of America to or for the benefit of US Persons. This is an information-only document derived from publicly available facts. It does not, and is not intended to, constitute investment research or marketing. No representation or warranty, express or implied, is given by any person as to the accuracy or completeness of the information and no responsibility or liability is accepted for the accuracy or sufficiency of any of the information, for any errors, omissions or misstatements, negligent or otherwise. Any views and opinions, whilst given in good faith, are subject to change without notice. Kepler Partners LLP (including its partners, employees and representatives) or a connected person may have positions in or options on the securities detailed in this report, and may buy, sell or offer to purchase or sell such securities from time to time, but will at all times be subject to restrictions imposed by the firm s internal rules. A copy of the firm s conflict of interest policy is available on request. Past performance is not necessarily a guide to the future. The value of investments can fall as well as rise and you may get back less than you invested when you decide to sell your investments. It is strongly recommended that Independent financial advice should be taken before entering into any financial transaction. PLEASE SEE ALSO OUR TERMS AND CONDITIONS Kepler Partners LLP is a limited liability partnership registered in England and Wales at 9/10 Savile Row, London W1S 3PF with registered number OC Kepler Partners LLP is authorised and regulated by the Financial Conduct Authority. 6