Real estate is certain to remain unloved until interest rates have peaked or start to move downwards. The latest inflation data indicates that that point may not be that far off, so now may be the opportune time to pick up a well-run property company on the cheap.
The vast majority of the sector is trading on substantial discounts to NAV, so sorting the wheat from the chaff may prove tricky.
One that stands out like a sore thumb is Tritax EuroBox. The European logistics company’s discount has dumbfoundingly averaged a touch under 40% over the last year, breaching 50% at one point. However, recent announcements suggests that this is wholly unjustified.
Boxing clever
Firstly, earlier this month the company sold an asset in Germany for €64.6m – in line with its book value at 31 March 2023, which gives us confidence in the validity of its NAV.
This week it also announced two lettings – one at a 32% premium to current rent and 16% above the independent valuers’ numbers – estimated rental value (ERV) – and one at a newly completed development in Italy inline with ERV and its own development appraisal.
This indicates to us that the supply and demand dynamic in the continental logistics sector continues to be in the landlord’s favour. It is true that macroeconomic caution amongst businesses has started to feed through to occupier take-up, with letting deals in the first half of 2023 below the exceptional levels recorded in recent years, but this is still in line with pre-COVID levels.
There has been a step up in occupier activity from manufacturing companies – evidence that near-shoring, which has been talked about as an occupier trend for three years, is starting to feed through to actual take-up. Since the outbreak of the COVID-19 pandemic, manufacturers have shifted their supply chain strategies to avoid disruptions. Supply chains are becoming shorter, with some manufacturing moving away from the Far East and China and back to Europe.
Vacancy remains low
Vacancy rates remain close to historically low levels, despite a slowdown in leasing activity, with the average vacancy rate across European logistics at 3.5% at the end of the first quarter, according to Savills, up from a low of 3.1% in 2022 but still one of the lowest levels on record.
The cost of finance has kiboshed many speculative development plans, which should translates into reduced completions later in the year and keep vacancy rates under control. In certain markets, such as Barcelona where EBOX’s largest asset is located, there is exceptionally low vacancy of sub-2%.
The low vacancy rate continues to be supportive of rental growth. This was evident in EBOX’s portfolio where it recorded rental growth of 10.4% on a like-for-like basis to €78.6m in the 12 months to 31 March 2023 (5.8% in the six months). EBOX’s manager expects that annual rental growth this year will be at a slower pace than in recent years – in the mid-single digits.
Reversion potential
EBOX’s portfolio has a reversion potential of 15.3% or an additional €12m of rental growth if assets were relet at ERV. On top of this, inflation-linked leases should capture additional rental uplifts throughout the remainder of the year. Of the leases that were linked to full CPI to come up for review in the six months to 31 March 2023, the average annual uplift was 10%. Although inflation is expected to moderate substantially, Oxford Economics forecasts that the average inflation in Europe to be 4.2% per year over the next three years. At this level EBOX could capture an additional €5.9m of rent from inflation uplifts built into its leases.
Covered dividend
Rental income growth (plus a lowering of costs through a decrease in management fees) has boosted earnings and allowed EBOX to fully cover its dividend for the past three quarters. The board states that it expects the full-year dividend to be covered too – even with the loss of earnings from sales and a potential small increase in debt costs.
Further disposals planned
In an effort to bring its LTV down to a more conservative level of around 40% and maintain its investment grade rating, the company will sell at least €150m of assets over the next 12 to 18 months. These would be on assets where the company has completed its asset management plan (and therefore further rental income growth is limited) or on assets that it believes display some risk – either on the part of the tenant or the building (that did not meet sustainability credentials and would be too costly to implement). Its recent €64.6m sale in Hammersbach, Germany, was one that fell in the former category. The company completed a re-letting of the property in 2022 that resulted in a 23.7% increase in rental income. It acquired the asset in 2019 for €50.6m, demonstrating the impact of asset management initiatives.
Cheap debt – although quite a lot of it
EBOX’s plan to lower its LTV is understandable. At 31 March 2023, the company had total drawn debt of €779.0m, equating to an LTV ratio of 44.9%. Including capital commitments for development and asset management projects, the group’s proforma LTV was 46.0%.
The majority of the group’s debt is fixed (73%), with its €500m senior unsecured green bond (which has a coupon of 0.95% per annum) maturing in 2026 and a €200m US private placement (which is made up of three tranches with an average coupon of 1.37%) not maturing until 2029. The group’s €250m revolving credit facility (RCF – of which €79m is currently drawn, with a further €33m earmarked for near-term capital commitments) is not fixed, however, and is the target of the company’s disposal programme.
The group’s average cost of debt was 1.22% at 31 March 2023. This would rise to a maximum of 1.46% if the whole of the RCF was drawn (which is not the intention – in fact the drawn portion is expected to decrease from asset sales).
Expectations of an easing of the interest rate in Europe, where inflation has fallen sharply, plays to the theory that property valuations have bottomed out. Trading at such a wide discount to NAV with the fundamentals still in its favour would suggest a re-rating of Tritax EuroBox’s shares is on the cards.