Picking AIM’s property performers 

Property is stirring again. This bellwether of the economy is showing signs of life after the traumas inflicted by the credit crunch and recession.

Many companies are moving to exploit the new opportunities they see, as yields in the right areas fall and values rally. Significant uncertainties remain and some companies prefer overseas property to that in the UK, but there are profits to be made by canny investors.

Tim Walton, an entrepreneur with a formidable track record in this field, has raised £110 million at £1 a share on AIM for LXB Retail Properties, which he set up six years ago to buy and develop properties in out-of-town retail parks. The company intends to take advantage of current low prices and buy older retail parks with short leases to redevelop them into more modern complexes that will attract large retailers willing to pay higher rents.

Walton’s team is putting £12.5 million into LXB, which is advised by JP Morgan Cazenove and Oriel Securities and can expect solid backing. Colette Ord, sector analyst at stockbroker Numis, says this is one of several floats now being lined up, some focusing on niche parts of the market and hoping to tempt European investment groups, now attracted by the yields available on prime UK property and sterling’s current weakness. 

Max Property Group, brought to AIM in May with a £220 million issue at £1 by Nick Leslau, a seasoned property entrepreneur with an unparalleled record for timing, has completed the £227 million purchase of the collapsed Industrious Group’s portfolio of diversified industrial properties. The portfolio will yield a handsome 10.3 per cent after costs, and the deal leaves Max, which took a £128 million non-recourse loan from a German bank, with £110 million of free cash.

Another AIM counter, First Property Group, which has successfully built up a £310 million portfolio of warehouses and other properties in Poland and elsewhere in Eastern Europe, is considering returning to the UK market. Having gone for Poland when yields at the peak of the UK market had become unattractive, chief executive Ben Habib is contemplating starting a UK fund, targeting minimum yields of 6 per cent.

Veteran tycoon Gerald Ronson’s private Heron Corporation has high hopes for The Peak, its new 78,800 sq ft headquarters building opposite London’s Victoria station. The building incorporates renewable energy technologies and, claims Heron, offers ‘a realistic alternative to London’s core West End market’.

Commercial breaks
These moves are taking place amid signs of improvement, at least in prime commercial property. After seeing an average 45 per cent wiped off the value of commercial property between the 2007 peak and early summer this year, the sector’s benchmark IPD index showed a 1.1 per cent rise in September, its steepest monthly gain in three years.

International sector adviser DTZ has predicted an 8 per cent increase in good-quality City rents next year while property consultant Savills recently noted that London yields had fallen by 0.75 per cent to 6.25 per cent in the City and 5.5 per cent in the West End. It also reported that, though banks continue to impose tough terms, 23 lenders were ready to advance more than £20 million for such projects and six were willing to lend more than £100 million, almost double the numbers identified six months previously.

Fully listed developer Minerva, with major projects in the City of London and elsewhere, sees ‘signs of improvement’ in the market, after downward revaluations caused it a £287 million annual loss. Having agreed new terms for £800 million of debt, the company is ‘in a good position to take advantage of a recovery in the market’, declares chairman Oliver Whitehead.     

Simon Embley, chief executive of fully listed LSL Property Services, clearly thinks the time is right if the terms are right. LSL has paid £1 to battle-scarred Lloyds Banking Group for HEAL, the former Halifax estate agency group with 218 branches. LSL, whose shares have risen tenfold from a 12-month low, aims to absorb HEAL’s branches into its own Your Move, Reeds and Intercounty operations, making it the UK’s second-largest estate agency network, with an expected £22.2 million of HEAL cash to cover necessary restructuring and other costs.

Mixed messages
But, before plunging into companies in the sector, investors must appreciate that the market is still, as Numis’ Ord puts it, ‘sending out mixed messages’, and they should be ready to adopt a selective approach. Prime property has rallied better than other categories, regional differences are strong and the market has not welcomed every new issue.

In the summer, veteran property entrepreneur David Lockhart had to shelve plans to float property vulture fund New River Retail on the London Stock Exchange for £250 million. He did, however, manage to raise £25 million for the company on AIM at 250p and the shares have gone to a modest premium at 275p.

Crucially, there remains uncertainty about how much property and how many deals the banks have not yet foreclosed on, because doing so would do embarrassing damage to their own painfully reconstructed balance sheets. Sceptics see this policy of ‘extend and pretend’ as a potential impediment to growth. 

The prospect of a prolonged, slow drip of individual receiverships, rather than a cathartic blitzkrieg paving the way for sustained recovery, is one reason that Glyn Hirsch, chief executive of AIM-quoted Raven Russia, gives for staying out of the UK market for now. ‘If this is the bottom of the market, it has been the most benign property downturn I’ve ever seen,’ he says.

Despite Savills’ report, bank caution on lending to the sector remains another problem in Hirsch’s view. ‘Without gearing, yields would have to be in double figures to make it worthwhile.’

In a hangover from the recent bubble, chunks of the property empire of Syrian-born tycoon Simon Halabi, including City head offices and the In and Out Club in Piccadilly, have been put on the market after receivers were appointed. Halabi’s company had defaulted on £1.5 billion of bonds tied to the properties.

In today’s more conservative climate, one approach would be to invest in fully listed property income funds, whose yields are covered by the returns on their investments, such as UK Commercial Property Trust or Standard Life Select Property Income. But for those not averse even now to an element of risk, several AIM companies vie for attention.

Retail therapy
Glasgow-based Terrace Hill, which is active in food store developments with the likes of J Sainsbury and others and has incurred losses on revaluations, reckons ‘values have bottomed for prime property, though that may not be true everywhere for secondary property’, according to chief executive Philip Leech. Reflecting a widespread experience, he argues that ‘people are paying good prices for good assets, but very few people are selling’.

Terrace Hill recently completed a £27.7 million forward funding with insurance group Aviva’s Investors Pensions Ltd to develop and sell a Sainsbury’s food store in Bishop Auckland,
County Durham. The property has been pre-let to Sainsbury’s on a 25-year lease at an initial rent of £18 per sq ft, for £1.7 million a year, reflecting a 5.7 per cent initial yield.

Leech believes that the price achieved in the deal ‘reflects a strong appetite among investors for well-let food store developments’. He maintains that this ‘should enhance the returns we expect from our pipeline of similar projects’.
Among the real estate investment trusts, which pay no corporation or capital gains tax but must distribute 90 per cent of their rental profits as dividends, Local Shopping REIT is now looking at possible corporate acquisitions, says joint chief executive officer Mike Riley. The company is also working with banks on restructuring deals.

Local Shopping, which floated at the market peak in 2007 with ‘575 deals and a £210 million portfolio of small shops from Elgin to Penzance’, has steered clear of fancy shopping malls, where purchase yields were low and rates, capital expenses, service charges and now vacancy rates are high (‘27 per cent’, suggests Riley), in favour of smaller retailing outlets. ‘We stopped buying in August 2007, because we realised the world was turning.’

Now, with purchase yields up from 6.5 per cent to 7.2 per cent, Local Shopping has funding fixed at 5 per cent till 2016 and is buying on yields of 9 per cent, says Riley, with tenants putting down three months’ rent as deposit and on average paying an affordable 7 per cent of turnover as rent. Buying at auction produces the best yields, around 8 per cent, he says, and Local Shopping’s small tenants are not in a position to claim rent holidays and other perks demanded by large retail groups. 

Greener pastures?
First Property is not the only company to have sought better yields abroad during the recent UK property boom. Glyn Hirsch and friends set up Raven Russia in 2005 ‘because of yield compression’ at home.

Raven picked warehousing logistics as an undersupplied sector there, entered joint ventures with locals and now claims to see returns ‘in the teens’. With 48 per cent gearing, Hirsch suggests that the company, whose shares plunged from a £1 float price to 1.5p before rallying to 43p now, will achieve a £56 million annual income level by next spring.

The German market has attracted several companies, though that country’s own economic setbacks have produced mixed results. Isle of Man-based Speymill Deutsche Immobilien, with a core portfolio of ‘blue collar’ residential buildings yielding some 6.5 per cent, is still de-leveraging after a 13 per cent fall in net asset values, says manager Nigel Caine, and has streamlined its property management, refurbished its properties and ‘driven down vacancies’.

He says the loss-making company has negotiated non-core asset sales and is experiencing rising income, with profitability in sight ‘in the next financial year’. Meanwhile, another Germany fan, Guernsey-based Sirius Real Estate, has renegotiated nearly £300 million of bank facilities and is ‘in good shape’, says chief executive officer Kevin Oppenheim.

He argues that the company, which spent two years from 2006 buying mixed-use commercial sites nationwide on six to eight per cent yields to upgrade as ‘flexible workspaces’, is benefiting from its focus on secondary sites for smaller businesses. Demand for larger units has collapsed in Germany, he declares, but Sirius is receiving ‘100 new enquiries a week’ for its ‘mini-business centres’.

Supporting the development of India’s infrastructure is where Alastair King, chief executive of London-based Eredene Capital, sees the most tempting long-term prospects, with backing from the hard-nosed Cayzer family’s Caledonia investment group and the similarly astute Ruffer fund management outfit. The loss-making company, which raised £7 million in August at 20p, invests in warehouse logistics and port upgrading in India’s fast-growth regions, doing deals with well-connected blue-chip local concerns, and its shares, having collapsed from 97.75p to 7p during the past year, have lately been showing some signs of life.

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