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Custodian Property Income REIT to merge with abrdn Property Income Trust

230526 reit mergers

The boards of Custodian Property Income REIT (CREI) and abrdn Property Income Trust (API) have agreed to a merger of the two companies. 

CREI will acquire the entire issued and to be issued share capital of API, with each API share receiving 0.78 new CREI shares

The exchange ratio is based on the unaudited EPRA Net Tangible Asset value of each of CREI and API as at 31 December 2023, adjusted to reflect post balance sheet asset disposals, the fair value of each company’s debt and derivatives, the relative levels of dividend cover between the two companies and the costs expected to be incurred by each party in connection with the merger.

Following completion of the merger, existing CREI shareholders will hold approximately 59.7% and API shareholders approximately 40.3% in the enlarged group

Applying the exchange ratio to the closing price per CREI share of 79.6p on 18 January 2024, API is valued at £237m and each share at 62.1p. This represents a premium of 29.4% to the last night’s closing price of 48.0p and 26.5% to the three-month volume-weighted average price of 49.1.

It is however a 24.5% discount to API’s last reported NAV of 82.2p on 30 September 2023.

Reasons for merger

CREI and API share an income-focused investment strategy with an emphasis on regional, below-institutional sized assets that are well-positioned to capture the rental growth and yield advantage available in order to generate higher income returns and capital growth for shareholders.

The CREI board and the API board believe that the merger would bring together two complementary portfolios to create a differentiated REIT with enhanced diversification and share liquidity and a fully covered and sustainable dividend for shareholders.

The boards said that they expect shareholders to benefit from:

  • A substantially larger portfolio with approximately 200 assets and a combined property value in excess of £1.0bn as at 31 December 2023; 
  • An enhanced portfolio diversification by asset, geography and tenant with broad-based regional exposure, with 50% of the combined group’s income derived from the top 54 tenants, an average lot size of approximately £5.1m and similar tenant covenant profiles as at 31 December 2023;
  • A continuation of CREI’s focus on below-institutional sized assets which delivers greater diversification, with no single tenant accounting for more than 2% of the rent roll. This focus enables CREI to find mispriced assets and make counter-cyclical investments in order to secure future rental and capital growth;
  • A suitable balance between the main commercial property sectors, in keeping with each of CREI’s and API’s existing policies, including significant exposure to the industrial sector (representing 44% of the combined group’s ERV as at 31 December 2023) which continues to benefit from low vacancy levels, limited new supply, strong occupier demand and, hence, rental growth; 
  • Meaningful reversionary potential with the combined ERV of £84.3m exceeding the combined passing rent of £68.1m by 24% at 31 December 2023;
  • A shared commitment to sustainability underpinning the shared asset management strategy with 81% of the combined portfolio holding an EPC rating of C or above;
  • Material cost savings, comprising £1.0m of recurring annual cost savings from a reduction in management fees due to CREI‘s tiered fee structure and the removal of duplicated corporate expenses and other potential operational efficiencies; and £2.1m of additional non-recurring cost savings during the two-year transition period as a result of a reduction in management fees payable to Custodian Capital;
  • A stronger and more resilient balance sheet, with the expected retention of CREI’s and API’s existing debt facilities implying a pro forma LTV of approximately 30.2%, a weighted average cost of debt of 5.0% and a weighted average debt maturity of 3.8 years. The aggregate debt portfolio of £225m of fixed rate debt expiring between 2025 – 2032 and the £125m of revolving credit facilities will allow for the ongoing financing of the combined group in the long and short term;
  • An expected uplift in annual dividends payable to API shareholders, with an objective of growing the dividend on a sustainable basis;
  • Creation of an enlarged REIT with an enhanced market profile, broader appeal to investors, greater share liquidity, and the scale to support a larger weighting in key indices with potential for inclusion in the FTSE 250 Index in due course;
  • Diversification of the shareholder register of the Combined Group with a broad mix of private and institutional investors, while enabling mutual shareholders to consolidate their holdings across the two companies; and
  • Continued focus on corporate governance, with the CREI board benefiting from the added expertise of certain API directors and the transition to a fully independent board following the integration of the two companies.

Reasons for API directors’ recommendation

Over the last 18 months API, along with other diversified investment trusts, has had to contend with the significant challenges facing the real estate sector as a whole, with rising inflation leading to a substantial increase in interest rates to levels not seen since before the Global Financial Crisis. This in turn has impacted investor sentiment, real estate capital values, transaction volumes and equity market liquidity.

In API’s case, these challenges have been compounded by the relatively small scale of the company and in particular the need to refinance its debt facility (consisting of a term loan and revolving credit facility) in late 2022, ahead of the previous maturity date in April 2023, at a time when politically induced gilt market volatility was at its height. API currently pays an annualised dividend of 4 pence per share which is not covered by EPRA earnings, with cover of approximately 80% for the last reported quarter ended 30 September 2023.

In recognition of these challenges, and the impact on API’s share price and discount to EPRA NTA per share, the board elected to undertake a comprehensive review of API’s strategic options in Q3 2023 with the objective of potentially delivering an uplift in value for API shareholders, as well as increased share liquidity and an enhanced and fully covered dividend for API shareholders.

Having assessed a wide range of potential strategic options in detail, the API board believes that there is a strong strategic and financial rationale for a combination with CREI.

API shareholders are expected to experience an annualised uplift in dividends of 7.3% (based on the exchange ratio and CREI’s target dividend of 5.5p per share) with the dividend being fully covered.

CREI shares have historically traded at a superior valuation to API’s, with an average discount to EPRA NTA per share of approximately 11% over the last year, compared to approximately 37% for API, and approximately 10% over the last 3 years compared to approximately 29% for API.

Comments on the merger

David MacLellan, chairman of CREI said: “The Board is pleased to announce the merger of CREI and API which it firmly believes will benefit both our existing and new shareholders. This transaction creates a well-positioned REIT of significant scale, giving the Combined Group’s shareholders the opportunity to participate in the returns from the complementary API and CREI portfolios, with a fully covered and sustainable dividend and a focus on ESG.

“In the current interest rate environment, security and resilience of cash flows, scale and liquidity, supported by a clear and compelling strategic direction are the defining characteristics of a successful REIT. The challenges the wider listed property sector has faced over the last 18 months highlight the merits of CREI‘s differentiated approach and operational robustness, which contribute to CREI’s strong rating relative to its peers. The income and income growth characteristics of the API portfolio should enable the merged entity to optimise earnings and maintain CREI‘s progressive dividend policy.

“Shareholders in the Combined Group will benefit from material cost savings and efficiencies along with benefitting from significant future growth opportunities to enhance shareholder returns”.

James Clifton-Brown, chairman of API added: “API has always sought to focus on delivering attractive, income-driven returns for shareholders. Over the years, API’s manager, abrdn Fund Managers, has assembled an attractive portfolio on the company’s behalf, with a weighting to more favoured areas of the market, a diversified tenant base and a focus on ESG. The board of API would like to thank the management team for the important role they have played in assembling and managing the portfolio.

“The Merger will enable API Shareholders to retain exposure to the portfolio and its growth prospects at a significant premium to API’s share price, with the prospect of superior share liquidity and an enhanced and fully covered dividend. The API Board believes that, with increased scale and an enhanced capital structure, the Combined Group will be well positioned for the future. The API Board is therefore pleased to recommend the Merger to API Shareholders.”

Further details

Following completion of the merger, Custodian Capital will provide investment management, administrative and advisory services to the combined group. It has been agreed between CREI and Custodian Capital that Custodian Capital will waive its management fee in relation to the NAV attributable to API for the first nine months following completion of the merger. There will also be a reduction in the management fees payable by CREI to Custodian Capital for a period of two years following completion of the merger. In recognition of the waiver and reduction in fees, the CREI board has agreed to an extension to the term of Custodian Capital’s appointment to the end of the two year period, at which point the contract will revert to being terminable on 12 months’ written notice.

Two of the existing API directors, Jill May and Sarah Slater, will join CREI’s board, bringing it to eight members. Following the integration of the API portfolio, the CREI board expects to conduct a review of its succession plan, assessing its composition and size to ensure an appropriate combination of skills, experience, diversity and knowledge.

CREI : API: Custodian Property Income REIT to merge with abrdn Property Income Trust

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