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Bond of the Week: 24 July 2018

Regional REIT 4.5% 2024

    
Regional REIT 4.5% 2024

There is a new issue in the retail bond market. It is a new name and not a charity bond.

 

Issuer

Regional REIT Limited

Currency

GBP

Nominal Amount

GBP TBA

Repayment

Bullet at par

Early Redemption

None

Coupon

4.5% Semi-annual in arrear

Coupon Dates

6 August  and 6 February

Announcement (Launch)

18 July 2018

Offer Period

18 July to 1 August at 12 noon

Signing Date

2 August 2018

AD Commission

0.375%

Issue/Settlement Date

6 August 2018

First Day of LSE/ORB trading

7 August 2018

Maturity Date

6 August  2024

Issue Price

100

Denominations

GBP100 subject to a minimum initial subscription of £2,000

SEDOL

TBC

TIDM

RGL1

ISIN Number

XS1849479602

Listing

London Stock Exchange, ORB

Interest Day Count Fraction

Actual /Actual

Business Day Convention

Following Unadjusted

Selling Restrictions

Only to be sold into UK, Isle of Man and Channel Islands

Lock- up/ Seasoning

None / Registered form

Governing Law

English law

Settlement

Euroclear, CREST, Clearstream

Lead Manager

Peel Hunt LLP

Authorised Distributors

A J Bell, Equiniti, iDealing, Redmayne Bentley

 

Regional = outside the M25

REIT = Real Estate Investment Trust.

So what can we say about this provincial property company? It is listed on the LSE with a market cap of £352 million (share price of 94.5p), it was admitted to the Official List in November 2015 with a target yield of 7-8% and now has a prospective dividend yield of 8.57%. Total equity (NAV) as at year end 2017 was £393 million. The assets/company is managed by London and Scottish Investments and the REIT originated from two closed end funds.

REITs are simple beasts which makes it easier for the investor to get to grips with and of course easier for me to write up. They are obliged to pay out a minimum of 90% of the net yield in the form of dividends (and Regional REIT has been paying out 97% but over time they expect the payout ratio to drift towards 90%). What needs to be looked at is the type and locality of the property invested in, the length of leases and tenant quality, the gearing and where you sit in relation to any other debt.

The company primarily invests in secondary offices and industrial assets. They have 164 properties, 1,026 tenants and 1,368 units with a contracted rent roll of £61.9 million. Office space represents 67% of the portfolio and this is expected to increase. The managers make the case that nationwide there is a steady stream of property conversions from offices to residential and very little new office space is built (Central London excepted). There is therefore a good chance that rents will spike. [In the case of industrial space virtually nothing new is being built]. Anecdotal evidence would seem to back up their claim. Of course, with REITS paying out 90% plus of net income to shareholders a rental increase does not immediately improve coverage ratios or LTV ratios (via debt reduction) from a bond holder’s perspective. Nevertheless bond investors want market conditions to be going in the right direction.

The regional split is as follows: South East 27%, Scotland 22.4%, Midlands 15.2%, North East 13%, North West 11.2%, South West 7.8% and Wales 3.6%. The Scottish management are (wisely) intending to divest away from Scotland which is over-represented in the portfolio - ideally it should be underrepresented. The greater distance put between your assets and the virtue signalling Wee Willy Krankie the better.

The £737million of property assets are leased to a wide variety of tenant types – e.g. wholesale and retail 14.2%, Finance and insurance activities 8.7% and public sector 8.9% etc.. Regional REIT have some good quality tenants on their books;  by way of example -Barclays Bank (2.6% of rent roll), E.ON (2.3%), TUI (2.2%), Scottish Widows (2.2%) and the Secretary of State for transport (1.1%).

The weighted average life of the leases is 5.45 years with 3.5 years to the first break (which in terms of visibility of income doesn’t seem too shabby to me). The days of hugely long leases, except for large office blocks occupied by major firms, is fading away. I know when we have moved office we are offered and insist upon a maximum 5 year break. Occupancy is 85.3% (they are aiming for 90%) and generally when making a new investment they will only buy if the building is at least partially let – they do not make speculative investments in newly built unlet offices. The occupancy rate at 85% represents the fact that new purchases of buildings, although partially let, are normally not fully let.

Gearing. Net loan to value is 45% and they are targeting 40%. The existing debt is secured with an average cost of 3.28% (plus some costs). The weighted average unexpired debt term is 6 years. Interest payable is covered 3.8x. This all seems eminently safe from a bond holder’s perspective. However, in your evaluation don’t forget the retail bond will not be secured (unlike the bank debt). But it does pay 4.5%. The assets together with the secured debt (which has no recourse to the parent company/bond issuer) are held in various subsidiaries. The bond issued by the parent Regional REIT then has the right to any residual value of the various subsidiaries after the satisfaction of the secured debt - in the unlikely event that something goes wrong. Another reassurance from the bond holder’s perspective is the direction of travel, in terms of funding, that Regional REIT are intending to take. This bond is designed as a minimum to replace a loan of £47 million that is maturing early next year and any additional amount raised will be used to pay off secured debt. Should this bond issue be successful then over time there is the suggestion that some secured debt will be replaced by unsecured bond debt although like most REITs they will probably keep a mix for the foreseeable future; the more secured debt is replaced by unsecured debt the less the unsecured debt is disadvantaged by having debt ahead of it. [The explanation for replacing bank debt is the same I keep hearing from new borrowers in the bond market; to get banks off the companies’ backs it is worth paying a bit extra for your debt].

Covenants.
1) Maximum LTV debt of 75% (a lot of head room over the targeted 40% debt to LTV).
2) Maximum 60% secured debt to LTV.
3) Interest cover of 2x (currently 3.8x).
4) The company must take no action to jeopardise its REIT status.

Conclusion. Pragmatically I think this bond offers a safe and simple investment. Originally it was suggested the coupon would be 4% - fair but in the great scheme of things not exciting. I therefore bought the equity at an 8.5% yield; you might like to look at the equity yourselves as REITs are about as close as equities can get to bonds since they receive long term income which is then required to be passed through to investors. The shares are also trading at around 90% of NAV. Perhaps the equity might be compared to perpetual subordinated debt where there is some variability in the coupon/ dividend to be paid.

The bond does however represent a superior quality income in terms of risk compared with the equity. Now the coupon has been moved up to 4.5% it also looks good value. The six year tenor is relatively short for a new issue retail bond. The recent Blong Vilej 4.5% 2026 Retail Charity bond (two years longer) is trading 101-102% (it did briefly touch 103%). Of (some) relevance as to where alternative yields are, the secured Land Securities 1.974% 2024 yields 1.78%, unsecured Segro 6.75% 2024 yields 1.83% and Gilts for the period yield 1.03%. I shall therefore be buying some of the bond to add to the equity.

ODRB

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