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QD view – the right REIT?

Discounts to net asset value (NAV) in the property sector have been pretty eye-watering over the last few weeks as the market tries to price in an appropriate level of asset value deterioration in this high interest rate environment.

Some have been singled out more than others. Take the AIC’s Property – UK Commercial sector as an example. Discounts range from 6.5% to a whopping 47.8%. One company that has perennially had a narrower discount rating (and wider premium in better times) is the £154m market cap AEW UK REIT (AEWU). So why do investors favour this small-cap REIT over some of its larger peers?

One thing that has always been a draw has been AEWU’s consistently high dividend of 2p a quarter (a rate maintained for 28 consecutive quarters). It gained extra brownie points for maintaining that level throughout the pandemic, when most of its peers suspended or cut the level they paid.

The dividend has not been covered by earnings for some time now, however. In its half year results to 30 September, earnings per share was 2.58p giving it a dividend cover for the period of 64.5%. This is primarily down to planned vacancy in two properties that have now been sold. Attaining vacancy at these properties – in Glasgow and Oxford – was required to maximise their sale values to alternative use developers. Now that the company has sold these assets it is sitting on almost £40m of cash that it needs to deploy into income generating assets.

It is a good time to have some cash in a market where values have been falling. The manager, Laura Elkin, says she is confident of investing the proceeds by the end of the first quarter of 2023 – with a significant acquisition to be announced this year. She adds that this activity should see the dividend be fully covered by the third quarter of 2023.

She told QuotedData that the company is seeing attractive opportunities in the market with the repricing of property and some forced sellers (such as open-ended property funds that have suffered redemptions). This, she adds, has allowed the company to target assets in prime locations that it wouldn’t have been able to afford before September.

The company’s focus on driving up rents through asset management puts it in good stead in the current environment. Falling capital values will be partly offset through rental uplifts, and the trust’s track record on that front and the low average rent of the current portfolio is encouraging. For a REIT like AEWU and its peers, rental income is the key metric to look at.

Cost of debt has been thrust into the spotlight recently and provides another tick in the box for AEWU. In a move that now looks like a masterstroke, the company refinanced its £60m loan (which was due to mature in October 2023) in May 2022 at a fixed rate of 2.959% for five years. This replaced a loan facility with RBS that was priced at a floating rate.

Where real estate values move out to over the next year is difficult to predict (there is an argument that valuers were gung-ho with their property valuations at the end of September with 10-year UK government gilts having reduced to just over 3% in recent days from over 4.5% in the days following Kami-Quasi), but on the earnings front AEWU is in a good place to cover its peer-leading dividend.

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