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AEW UK REIT plc (AEWU)
17 November 2021
AEW UK REIT PLC
Interim Report and Financial Statements
for the six months ended 30 September 2021
AEW UK REIT PLC ("AEW UK REIT" or the "Company"), , which holds a diversified portfolio of 35 commercial investment properties throughout the UK, is pleased to publish its Interim Report and Financial Statements for the six months ended 30 September 2021.
Mark Burton, Chairman of AEW UK REIT, commented: "We are very pleased with the strong performance over the period with the Company's NAV increasing by 10.96% and a total shareholder return of 28.37%. . The valuation of the Company's property portfolio rose by 9.81% on a like-for-like basis, chiefly driven by its industrial assets. The sales of Langthwaite Industrial Estate, South Kirkby for £10.84 million and Wella Warehouse, Basingstoke for £5.86 million post period end were well above both purchase prices and book values.
The Company continues to see a number of attractive investment opportunities as it seeks to deliver further attractive returns to shareholders and support the 8p annual dividend. The Company made two acquisitions during the period, and one after half-year end, that are aligned with AEWU's strategy of adding value through active asset management by renewing current tenancies and securing new tenants. "
1 The valuation figure is reconciled to the fair value under IFRS in note 10.
I am pleased to report the unaudited interim results of the Company for the six months ended 30 September 2021 (the 'period'). The Company held a diversified portfolio of 35 commercial investment properties located throughout the UK with a value of £206.69 million as at 30 September 2021.
The Company's NAV has performed well over the period, having increased by 10.96%. The valuation of the Company's property portfolio rose by 9.81% on a like-for-like basis over the period, chiefly driven by its industrial assets. The sales of Langthwaite Industrial Estate, South Kirkby for £10.84 million and Wella Warehouse, Basingstoke for £5.86 million post period end were undertaken at 1.9x and 1.7x the purchase prices, respectively. The resulting profits achieved on disposal were £2.25 million and £1.93 million above book values, respectively, providing a boost to the Company's NAV. The Company closed the period in a position to take advantage of attractive opportunities to reinvest as a result of its cash position and debt covenant headroom. The Company has maintained a conservative Loan to NAV ratio, which stood at 29.00% at 30 September 2021, and had a healthy cash balance of £15.16 million.
Following the disposal of the Corby and Solihull sites in the prior period, the Company reinvested the sales proceeds to make two acquisitions during the period. Arrow Point Retail Park in Shrewsbury was acquired in May 2021 for £8.35 million and is a fully-let, purpose-built retail park prominently located on a busy estate and providing a Net Initial Yield ('NIY') of 8.7%. The second, 15-33 Union Street, Bristol, is a prime retail site located on a busy pedestrian thoroughfare in Bristol city centre and was purchased for £10.19 million, equating to a low capital value of £161 per sq ft and reflecting a NIY of 8.0%. Both of these assets provide opportunity for value growth in the medium to long term, and also have strong and stable income streams from their tenancy profiles.
The ongoing remedial works in Blackpool, along with the vacancy costs at Glasgow where we have sold an asset conditional on obtaining vacant possession, have constrained the portfolio's overall EPRA EPS, which was 3.45 pence for the period, providing a dividend cover of 86.10%. Following the planned sale of Glasgow, currently anticipated in December 2021, and completion of the works at Blackpool in early 2022, we expect this cost overhead to fall, leading to an increase in the EPRA EPS. The Company has made one acquisition post period-end of a retail park in Coventry for a purchase price of £16.41 million. This presents opportunities to add value through active asset management by renewing current tenancies and securing new tenants, which will further add to the recent strong income return and NAV growth achieved by the Company. The acquisition is accretive to EPRA EPS and takes the Company close to full investment.
The Company continues to work with its tenants in order to manage the difficulties posed by the pandemic. To date, the tenancy profile of the Company has proved to be resilient, demonstrated by the Company's low underlying vacancy rate of 5.43%* by Estimated Rental Value ('ERV') as at 30 September 2021. Rent collection rates have remained high for the March and June 2021 quarters, being 99% for both and 87% has been collected to date for the September 2021 rent quarter. These collection rates are high in comparison with the averages seen in the wider market and we expect that ultimate rates of collection, following the expiry of longer-term payment plans, should result in collection rates in excess of 98%. There are a small number of tenants who continue to face challenges in the current environment, and in a small number of cases the Company has agreed a longer-term payment plan to recover rental income in full over an extended period. A prudent assessment has been made of the recoverability of the Company's outstanding debts and a provision has been made in the financial statements for potential debt write-offs.
The office park at Oxford continues to perform well with its transition to life sciences/medical use, a sector which is seeing particularly strong investor demand at present. Moreover, after a tumultuous period for the retail sector, we have seen valuations stabilise this period, with our valuations increasing by 1.36% on a like-for-like basis, particularly driven by our new retail warehousing holding in Shrewsbury. Stock selection and active asset management continue to be key features of the Company's strategy and drivers of performance. During the period, the Company completed a number of lettings and lease renewals, the most notable of which was two new lettings at our office holding in Bristol, both of which were 15% above ERV. These are noted in more detail below in the 'Asset Management' section of the Investment Manager's Report.
The Company's share price was 102.80 pence per share as at 30 September 2021, representing a 6.56% discount to NAV (31 March 2021: 83.20 pence per share, representing a 16.1% discount to NAV). Subsequent to the period-end, the Company's share price has experienced additional growth, causing a further reduction in the discount to NAV.
* Including vacancy contributed by Bath Street, Glasgow, which has been sold with the condition of vacant possession, the vacancy rate was 8.59%.
* see note 8 of the Financial Statements for the corresponding calculations.
The Company has a £60.00 million loan facility, of which it had drawn a balance of £50.50 million as at 30 September 2021 (31 March 2021: £60.00 million facility; £39.50 million drawn), producing a Loan to NAV ratio of 28.97% (31 March 2021: 25.15%).
The unexpired term of the facility was 2.1 years as at 30 September 2021 (31 March 2021: 2.6 years). The loan incurs interest at 3-month SONIA +1.4%, which equated to an all-in rate of 1.47% as at 30 September 2021 (31 March 2021: 3-month LIBOR + 1.4% equating to an all-in rate of 1.44%).
The Company is protected from a significant rise in interest rates as it has interest rate caps in place. Throughout the period and up to the date of this report, the Company had in effect interest rate caps on a notional value of £51.50 million of the loan, capped at 1.00%, which resulted in the loan balance being 102.0% hedged as at 30 September 2021.
As noted in the KPIs, the Company targets long-term gearing of 35% Loan to NAV, which is the maximum gearing on drawdown of the RBSi facility. The Board and Investment Manager continue to monitor the level of gearing and have the ability to adjust the target gearing according to the Company's circumstances and perceived risk levels.
The Company passed its Interest Cover Ratio ('ICR') tests for April, July and October 2021 with significant headroom.
The Company has continued to deliver on its target of paying dividends of 8.00 pence per share per annum. During the period, the Company declared and paid two quarterly dividends of 2.00 pence per Ordinary Share, in line with its target. Dividends for the period were 86.00% covered by EPRA EPS.
It remains the Company's intention to continue to pay dividends in line with its dividend policy, and the existing portfolio and investment opportunities support this policy. However, the outlook remains unclear in the wake of the COVID-19 pandemic and in determining future dividend payments, regard will be had to the circumstances prevailing at the relevant time, as well as the Company's requirement, as a UK REIT, to distribute at least 90% of its distributable income annually.
The easing of most of the remaining COVID-19 restrictions, combined with the continued rollout of the vaccination programme, has lifted most economists' outlook for the post COVID-19 rebound in the second half of 2021. In light of this, the property market has experienced a gradual recovery, with rent collection levels greatly improving, as cash flow pressures on tenants ease. With its strong cash position and borrowing covenant headroom, the Company is well positioned to take advantage of attractive opportunities coming to the market. During the period, the Company has displayed strong NAV performance, reflecting the geographical diversity of the portfolio, its circa 50% exposure to the industrial sector and the fact that many of its assets benefit from viable alternative use potential, limiting downside risk and volatility.
In the near term, the Board and Investment Manager will continue to focus on minimising the legacy impact of COVID-19 on its stakeholders and, as more attractive opportunities arise in the investment market, will aim to find suitable assets to build earnings back to a fully covered dividend. The developing economic conditions will be monitored closely and the Company's strategy adjusted accordingly. It is hoped that the start of 2022 will build upon the economic recovery of the second half of 2021, providing conditions to enable further growth of the Company
16 November 2021
Key Performance Indicators
* Glasgow has exchanged to be sold with condition of vacant possession.
Investment Manager's Report
The easing of most of the remaining COVID-19 restrictions has increased market optimism in both the direct and indirect markets. Oxford Economics' latest forecasts published in mid-September 2021 indicate UK GDP growth to be 6.9% for the whole year, compared with the 9.8% contraction in 2020. However, the Bank of England signalled its concerns on inflation being well ahead of its target in mid-October. Due to energy, labour and materials shortages UK inflation is expected to peak near 6% in early 2022. As a result, gilt markets are pricing in interest rate hikes starting in December 2021 followed by further increases in 2022. Despite these interest rate increases, Oxford Economics' latest forecast confirms the continued strong UK economic recovery with GDP growth of 6.7% in 2022.
Although the direct markets are still strongest in the industrial and warehouse sector, the next year is expected to be a year of recovery and growth where some parts of the retail and leisure sectors may be the beneficiaries. The Company is focusing on portfolio adjustments to take advantage of value opportunities, driven more by the specifics of the asset than the sector. This may see the Company realise profits through sales where it believes values have been optimised and where the funds can be recycled into assets with better growth potential going forwards. There is likely to be a slightly reduced weighting to business space and a rotation towards retail warehousing, leisure and a continued focus on assets with viable alternative use value. Assets whose current value is supported by long-term alternative use optionality, irrespective of current use, will be of increasing importance in our stock selection process. Moreover, recent changes to the Use Classes Order are likely to have a significant impact on portfolios in terms of broadening potential use. Finally, in line with market optimism and a period of post pandemic growth, rent collection rates have strongly improved and this trend is expected to continue.
The Company's NAV as at 30 September 2021 was £174.29 million or 110.01 pps (31 March 2021: £157.08 million or 99.15 pps). This is an increase of 10.86 pps or 10.96% over the period.
EPRA EPS for the period was 3.45 pence which, based on dividends paid of 4.00 pps, reflects a dividend cover of 86.00%. The increase in dividend cover compared to the prior six-month period has largely arisen due to improvements in rent collection levels, along with successful legal outcomes that have recovered significant arrears. Income across the tenancy profile has remained largely intact. Collection rates have reached 99% for both the March and June 2021 quarters respectively, with further payments expected to be received under longer-term payment plans. Of the outstanding arrears, £0.61 million has been provided for expected credit losses.
As at 30 September 2021, the Company has a £60.00 million loan facility with RBSi, in place until October 2023, the details of which are presented below:
Due to GBP LIBOR ending at the end of 2021, the Company transitioned to SONIA on 20 July 2021, with a credit adjustment spread of 0.0981%.
During the period, the Company disposed of Langthwaite Industrial Estate, South Kirkby, for net proceeds of £10.84 million. The Company made two acquisitions during the period being: Arrow Point Retail Park in Shrewsbury, which was acquired in May 2021 for £8.35 million, and 15-33 Union Street, Bristol, which was purchased in June 2021 for a price of £10.19 million.
The following tables illustrate the composition of the portfolio in relation to its properties, tenants and income streams:
Summary by Sector as at 30 September 2021
Summary by Geographical Area as at 30 September 2021
*like-for-like rental growth is for the six months ended 30 September 2021.
Source: Knight Frank/AEW, 30 September 2021.
Individual Property Classifications
The Company's top ten properties listed above comprise 49.2% of the total value of the portfolio.
Sector and Geographical Allocation by Market Value as at 30 September 2021
Source: Knight Frank valuation report as at 30 September 2021.
Top Ten Tenants
The Company's top ten tenants, listed above, represent 35.4% of the total passing rental income of the portfolio.
Source: Knight Frank valuation report as at 30 September 2021.
The Company completed the following material asset management transactions during the period:
Acquisitions - Arrow Point Retail Park in Shrewsbury was acquired in May 2021 for £8.35 million and is a fully-let, purpose-built retail park prominently located on a busy commercial estate, providing a NIY of 8.7%. The second acquisition, 15-33 Union Street, Bristol, is a retail/leisure site located on a busy pedestrian thoroughfare in Bristol city centre and provides a NIY of 8.0%. Both of these assets provide opportunity for value growth in the medium to long term as well as strong and stable income streams from their tenancy profiles.
Disposals - Sales of Langthwaite Industrial Estate, South Kirkby for £10.84 million and Wella Warehouse, Basingstoke for £5.86 million have now been completed, with the latter completing post period end. The sales prices achieved were 31% and 35% ahead of their March 2021 valuations, and also 1.9x and 1.7x their purchase prices, respectively.
Arrow Point Retail Park, Shrewsbury - We have extended British Heart Foundation's unexpired term to break by moving their November 2021 break option out to December 2024 in return for four months' rent free. The majority of the rent free was used to write off rent arrears predating the Company's ownership. British Heart Foundation's lease expires in November 2028.
Diamond Business Park, Wakefield - We have completed a new five year ex-Act lease at £41,866 per annum/£3.75 per sq ft on Unit 14, which reflects a rent 25% above the March 2021 ERV. The tenant has provided a rent deposit equivalent to six month's rent. Six months' rent free was given as an incentive.
40 Queen Square, Bristol - We have completed a new five year ex-Act lease to Brewin Dolphin at £103,770 per annum/£30 per sq ft versus the previous passing rent of £22 per sq ft and the March 2021 ERV of £26 per sq ft. A 12 month rent free incentive was given. We have now also completed a lease renewal to Candide Limited until February 2025 at the same rent of £30 psf (£116,970 per annum). The previous passing rent was £22.81 per sq ft and only 1.5 months' rent free incentive was given. These lettings at £30 psf have produced an increase in the property's valuation of £1.05 million (9.9%) over the past six months.
Vantage Point, Hemel Hempstead - We have completed a new five year ex-Act lease (tenant break option at the end of year three) to Netronix Integration Limited at a rent of £33,683 per annum/£14.50 per sq ft, which is £3 per sq ft above ERV. Four months' rent free incentive was given, with a further two months should the tenant not exercise their tenant break option at the end of the third year.
Above Bar Street, Southampton - We have exchanged on a new straight five year ex-Act lease to Shoe Zone at a gross rent of £80,000 per annum, subject to approximately £40,000 landlord works. 12 months' rent free incentive was given.
Sarus Court, Runcorn - We have completed a ten year lease renewal with NTT United Kingdom Limited (Dimension Data) at £5.75 per sq ft (£64,066.50 per annum) versus the previous passing rent of £5.25 per sq ft. There is a tenant break option in December 2025. Five months' rent free incentive was given. The valuation of this asset has increased by £1.05 million (15.3%) over the past six months to £7.9 million.
Vacancy - The portfolio's overall vacancy level is 8.59%. Excluding vacancy contributed by the asset at 225 Bath Street, Glasgow, the vacancy level is 5.43%. This asset has now been exchanged for sale for alternative use redevelopment as student accommodation. As a condition of the sale agreement, full vacancy must be achieved before the sale can be completed. Completion of the sale is expected in Q4 2021 - Q1 2022. The purchaser has submitted a planning application and is awaiting confirmation on a committee date. Regarding achieving vacant possession, only one tenant remains in the building having recently exchanged on the variation of W.A. Fairhurst's lease, bringing their occupation to an end on 31 January 2022, in exchange for an £800,000 surrender premium, plus nine months' rent free from 28 February 2021 to 1 December 2021.
Environmental, Social and Governance ('ESG') Update
The Company has maintained its two stars Global Real Estate Sustainability Benchmark ('GRESB') rating for 2021 and maintained its score of 65 (GRESB Average 72). A large portion of the GRESB score relates to performance data coverage where, due to the high percentage of single-let assets with tenant procured utilities, the Company does not score as well as funds with a smaller holding of single-let assets and a higher proportion of multi-let assets where the owner is responsible for the utilities and can therefore gather the relevant data.
We continue to implement our plan to improve overall data coverage and data collection for all utilities through increased tenant engagement at our single-let assets and by installing automated meter readers ('AMR') across the portfolio. So far, we are in the process of installing AMRs in all of our multi-let properties. We are also in discussions with the tenants of our top 10 single-let FRI assets (in terms of floor area) regarding the installation of AMR.
We endeavour, where the opportunity presents itself through a lease event, to include green clauses in leases, covenanting landlord and tenant to collaborate over the environmental performance of the property.
We continue to assess and strengthen our reporting and alignment against the framework set out by the Taskforce on Climate-Related Financial Disclosures ('TCFD') with further disclosure and update to be provided in the 2022 annual report and accounts. We are pleased to report the Company has maintained its EPRA Silver rating for sBPR for ESG disclosure and transparency.
We have an Asset Sustainability Action Plan ('ASAP') initiative, tracking ESG initiatives across the portfolio on an asset by asset basis for targeted/relevant and specific implementation of ESG improvements. In doing so, all managed assets and units have recently been contracted to High Quality Green Tariffs, ensuring that electricity supply is from renewable sources. All void/vacant unit supplies have also been transferred to High Quality Green Tariffs.
All managed assets will be moved to 'Green Gas' supplies in 2022.
We are underway with implementing initiatives such as a new landscaping/biodiversity programme at our retail warehouse in Barnstaple, replacing the existing plants and shrubs with a greater diversity of appropriate species which in turn will attract a wider variety of insects and wildlife to the property.
Lease Expiry Profile
Approximately £3.48 million of the Company's current contracted income stream is subject to an expiry or break within the 12 month period commencing 1 October 2021. 12.87% (£447,984) of this income (Indigo Lighthouse Solutions and WA Fairhurst) is attributable to our office holding in Glasgow, which has exchanged for sale. A further 9.38% (£326,668) of this income relates to a property where we expect the tenants to stay, renewing their leases. 18.31% (£637,238) of this income is in the industrial sector, where we anticipate strong occupier demand, low incentives and reversionary rents. Regarding the remainder, we will proactively manage, looking to unlock capital upside, whether that be through lease regears/renewals, or through refurbishment/capex projects and new lettings.
Source: Knight Frank valuation report as at 30 September 2021.
AEW UK Investment Management LLP
16 November 2021
Principal Risks and Uncertainties
The Company's assets consist of UK commercial property. Its principal risks are therefore related to the commercial property market in general, but also to the particular circumstances of the individual properties and the tenants within the properties.
The Board has overall responsibility for reviewing the effectiveness of the system of risk management and internal control which is operated by the Investment Manager. The Company's ongoing risk management process is designed to identify, evaluate and mitigate the significant risks the Company faces.
At least twice a year, the Board undertakes a formal risk review with the assistance of the Audit Committee, to assess the adequacy and effectiveness of the Investment Manager and other service providers' risk management and internal control processes.
The Board has carried out a robust assessment of the principal and emerging risks facing the Company, including those that would threaten its business model, future performance, solvency or liquidity.
An analysis of the principal risks and uncertainties is set out below. The risks below do not purport to be exhaustive as some risks are not yet known and some risks are currently not deemed material but could turn out to be material in the future. Changes to the principal risks since the date of the Annual Report and Financial Statements for the year ended 31 March 2021 are indicated below.
6. Fall in rental rates
Rental rates may be adversely affected by general UK economic conditions and other factors that depress rental rates, including local factors relating to particular properties/locations (such as increased competition).
Any fall in the rental rates for the Company's properties may have a material adverse effect on the Company's profitability, the NAV, the price of the Ordinary Shares and the Company's ability to meet interest and capital repayments on any debt facilities.
The Company builds a diversified property and tenant base with subsequent monitoring of concentration to individual occupiers (top ten tenants) and sectors (geographical and sector exposure).
The Investment Manager holds quarterly meetings with its Investment Strategy Committee and regularly meets the Board of Directors to assess whether any changes in the market present risks that should be addressed in the Company's strategy.
Probability: Moderate to High
Impact: Moderate to High
Movement: No change
7. Breach of borrowing covenants
The Company has entered into a term credit facility with RBSi.
Material adverse changes in valuations and net income may lead to breaches in the Loan to Value ('LTV') and interest cover ratio covenants.
The Company monitors the use of borrowings on an ongoing basis through weekly cash flow forecasting and quarterly risk monitoring to monitor financial covenants.
Low to Moderate
Impact: Moderate to High
8. Interest rate rises ...