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Bond of the Week: 23 November 2012

Unite Group PLC 6.125% 2020 


Unite Group (the FTSE 250 provider of student accommodation not the public sector trade union) has launched its first retail bond offering. The terms are as follows:

Issuer: Unite Group PLC
Type: Senior unsecured
Coupon: 6.125% semi-annual
Settlement: 12th December 2012
Maturity: June 2020 (7.5 years) 
Listing: London
Denominations: £100 (minimum subscription £2,000)
Lead: Investec/ Numis
Books close: 5th December or earlier
Isin: XS0856594642

Protective Covenants
Negative pledge: Yes
LTV Covenant: 75%
Interest cover: 1.5x
Change of control: Yes

“Buy to lets” aimed at students have been popular among pro-active private investors for some years. It has been appreciated that this has been a growth area in the rental market with good returns to be made. This is where many of the most savvy property investments have been made by individuals. Unite represents the professional or institutional approach to providing accommodation for students and they are the market leader.

Why has providing student accommodation been so lucrative for the private investor (although not particularly so for equity holders in Unite)? Apart from the fact that universities are often located in property hotspots and the existence of students themselves, via bars, café society, nightlife etc. can increase the desirability of an area, the answer is Demand. There are two threads to this. Firstly the astronomical growth in student numbers from 1 million in 1996 to 1.7 million in 2011 and secondly pent up demand from historic shortages of student accommodation as universities wish to offer living quarters to their intake rather than let them go out onto the general rental market.

Will demand (ie student numbers) continue to increase?  It is well known that domestic student numbers have exploded because successive government policies deliberately encouraged this for political reasons, proclaiming university education was for all. This explosion in tertiary education has of course been one of the reasons for the impoverishment of government finances. This burden has now been passed onto students, pauperised via £9,000 p.a. fees. The result is this avenue of increased demand has now been closed. Unite expects domestic student demand to be stable. Student demand could, I expect, even decrease although with unsatisfied demand of unplaced candidates at 24%, actual student numbers may be unaffected.

However, overall student numbers have also increased because of international demand and Unite believes with good justification that this will continue to grow. Foreign students already make up 18% of the student population as a whole and 26% in London. In 2001 there were 2 million internationally mobile students, in 2009 that had increased to 3.3 million. The UK (13%), after the US (20%), is the second most popular destination. Students come from all over the world but with a particularly large contribution from the EU and also a very significant number from the Far East. With English the international language, UK Universities (along with the US) dominating the university league tables and London the international and cosmopolitan city par excellence, it would seem logical that the UK can continue to attract a high and may be increasing proportion of the increasing internationally mobile student market.

What does Unite offer and where? The majority of their rooms are in Russell University towns and 45% of the stock is in London. They intend to increase their exposure to London (good for international students). Geographically the picture is encouraging. Unite builds modern rather characterless student blocks. Having looked on line all their offerings seem to have freshly painted bedrooms, mostly ensuite bathrooms, communal places to lounge about in and smart kitchens where students can cook beans on toast . The rooms even seem to have double beds. Standards seem to have both risen and fallen since my day. It is all a far cry from my year of living out. A bedroom sash window which wouldn’t close and had to be blocked with a blanket, a bathroom with no hot water, no shower and no functioning bath and the basement kitchen with resident snails and a cooker that gave you an occasional electric shock; ah those were the days. Then there was the front door that couldn’t be locked and was on the latch 24 hours a day and the girl who asked for a discount on her electricity bill as she had exchanged her 60 watt light bulb for one of 40. We refused – she lived in Kensington. I am not so sure that the modern student life as provided by Unite and others, does not lack something on the character forming front. Perhaps on the other hand there is still a craving by the domestic student for the “bespoke” experience as Unite’s blocks particularly attract foreign students. A very high 31% come from outside the EU. I was told that not only is this a growth area it was also good for dilapidations as the Chinese tendered to leave their rooms in a better state than they found them.

How safe does Unite appear from a bond perspective? They have developed their own blocks and from the start in 2000 there was very rapid expansion. In the first year they had 4,000 rooms and by 2007 that had increased to 37,000. Developing and rapid expansion are of course risky and from an equity perspective the share price is not dissimilar to where it was 12 years ago. The 2007 financial crisis provided a salutary shock to Unite (and all the other property companies that have come to the ORB). However, they have now changed or matured their business model and are settling down to be a rentier. This year from a base of 40,000 bedrooms they are adding a mere 1,500. Their new approach has brought benefits. The share price has moved up strongly this year and profit is up sharply: 2010 £4.1 million, 2011 £11 million and an expected £18 million in 2012.

The financial statistics have been trending in favour of bond holders. LTV has decreased from 63% in 2008 to 54% today. Importantly the short term target is an LTV of 50% and it may also be reduced further from there in futures years. Interest cover (various swaps have come off this year aiding profitability) has gone from 1.3X in 2008 to 2.6X in 2012. You can see the strength of the demand picture in the 96% occupancy rate for their rooms.

A point that has particularly encouraged fund managers who have looked at this deal is that 54% of Unite’s property has been leased directly, on durations of up to 25 years, to universities. Universities get to secure accommodation for their students (particularly first year freshers) and Unite locks in high occupancy rates. As many parents will attest to, students’ rental dues increase with a vicious regularity. Since 1978 annual rents have increased by a rather startling 2.5% average over inflation year on year . Unlike with the office, retail, and industrial sectors (which have seen falls in the periods 1988-92 and post 2008) in no year has the student rental index ever showed a decrease.  The most negative comment that can be made is that what goes up must come down and that which has risen furthest can fall furthest. To that I think can be quoted the old traders saw that “a trend is your friend” and that trend shows no sign of being broken.

From a bond holders perspective this issue is very promising. Let us have a quick look at the other property bonds in the retail bond market.

Issue Mid price Yield
PHP 5.38% 2019 100.7 5.25%
Workplace 6% 2019 102 5.64%
CLS 5.50% 2019 98.9 5.70%
St. Modwen 6.25% 2019 102.4 5.82%
Unite 6.13% 2020 100 6.13%

Please note none of the issuers are rated and they all demand our attention with different unique selling points. Please also note that they are all unsecured bonds and as property companies with secured borrowings from the banks the question of structural subordination (dealt with in previous issues) arises.

Conclusion. It seems fairly clear to me that this is a good buy. Unite has moved their model from that of being a developer to a much safer one of being a landlord collecting rents. Their sector, student accommodation, is one with good historic growth and good future potential. In addition like all property companies post the financial crisis when many of them suffered a near death experience (and those who didn’t saw what was happening elsewhere), there has been decisive management action to improve the financials. LTV is down and interest cover is up. Also on a comparative basis (see table above) it is cheap. I would think this should make both a good long term hold but also offers potential good capital gains in the near term. I shall be buying.

Oliver Butt Oliver Butt is a Partner in City and Continental LLP, a leading independent broker in fixed income. The author and or the LLP may hold a position in or trade in any of the securities mentioned above.

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