This Reit's wind-down has a silver lining for investors

The board of Residential Secure Income (RESI:57.7p), a real estate investment trust with secure inflation-linked returns, has proposed a managed wind-down of the company to return capital to shareholders.

The directors highlighted the liquidity of the shares, increasing investor demand for larger listed funds and a persistent, material share price discount to net asset value (NAV) as reasons for pursuing a portfolio realisation to maximise shareholder value.

Launched in 2017, when the company raised £180mn at 100p a share on the premium segment of the main market of the London Stock Exchange, RESI's aim was to make a meaningful contribution to alleviating the UK housing shortage by acting as an investment partner to housing developers (housing associations, local authorities and private developers) for affordable homes. Excluding a portfolio of 134 local authority properties that is in the process of being sold, RESI is solely focused on shared ownership housing and independent retirement rentals.

There are 252,000 shared ownership homes across England, and 20,000 new shared ownership homes are delivered annually, making it one of the fastest-growing housing tenures. RESI’s shared ownership portfolio consists of 757 homes with an average vacant possession valuation of £330,000 and accounts for 36 per cent of RESI’s total portfolio valuation. Homebuyers purchase a 25 per cent share of the residential property and pay a below-market rent on the remaining 75 per cent owned by RESI.

Shared ownership is required to be affordable to incoming shared owners, which typically means no more than 40 per cent of the post-tax income of new shared owners can be spent on total housing costs (mortgage, rent and any service charge). The average monthly rent on RESI’s properties is £483. Home buyers usually fund their initial equity stake with a 90 per cent mortgage and are responsible for maintenance, repairs and insurance, thus creating a strong alignment of interest.

RESI’s shared ownership portfolio has an open-market vacant possession valuation of £250mn, of which shared owners hold 38 per cent. It means that RESI’s share in these properties is £155mn, or £40mn (21p a share) more than the £115mn carrying valuation in its latest accounts. The properties would have to be sold on the open market to release the reversionary surplus, but it does highlight significant hidden balance sheet value.

RESI has borrowed £76mn from the Universities Superannuation Scheme (USS) on the shared ownership portfolio, with the debt inflating in line with the retail price index (RPI)-linked rent in RESI’s leases. The USS borrowing facility has more than 40 years to maturity in May 2065, and has an average interest rate of 1.1 per cent, well below the net yield of 4 per cent and leveraged yield of 8.2 per cent generated by the portfolio. The principal of the USS debt increases at a rate of RPI plus 0.5 per cent per annum with RPI capped at 5 per cent. The loan has an amortised cost of £87.3mn.

However, rising rental income on the portfolio underpins valuations and should also support an orderly realisation of RESI’s equity held in the 757 properties, assuming shareholders approve a managed disposal programme. Schroder Investment Management, Close Asset Management, BlackRock and Premier Miton are among the roll call of well-known institutional investors on the share registrar. In aggregate, the top 12 largest shareholders hold 59 per cent of the shares in issue.

Significant value in retirement portfolio

In addition, RESI owns 2,234 independent retirement homes that are let on assured tenancies on an average lease of six years and monthly rent of £854. Demand is strong, with occupancy rates of 96 per cent and rent collection rates above 99 per cent. Rental payments are relatively de-linked from the economy as tenants fund their rent through their pensions, income on savings and from other benefits such as housing benefit. Annualised net rental income of £11.6mn from the retirement portfolio is double that of the smaller shared ownership portfolio.

The retirement portfolio had a carrying valuation of £202mn in RESI’s latest accounts, but a materially higher vacant possession valuation of £243mn (£110,000 per flat). The reversionary surplus of £41mn (22p) is not embedded in RESI’s NAV. A £92mn drawn facility with Scottish Widows is secured by a first charge on the properties and is fixed at an attractive interest rate of 3.5 per cent until June 2043. The retirement portfolio generates an unleveraged yield of 5.7 per cent and a leveraged yield of 7.6 per cent.

Factoring in the disposal of its local authority portfolio, group pro-forma net borrowings of £160mn imply a loan-to-value (LTV) ratio of 50 per cent on the £317mn combined portfolio valuation. The LTV ratio drops to only 40 per cent after adding the £81mn (44p) combined reversionary surpluses to the £317mn property valuation. RESI has a market capitalisation of £110mn, or 25 per cent below EPRA NAV of £142mn (76.7p) and a 31 per cent discount to IFRS NAV of £155mn (83.6p), both of which exclude the reversionary surplus.

Increasing demand for inflation-linked income

A proposed orderly realisation of the portfolio looks well timed given that interest in high-quality real estate portfolios offering strong inflation-linked revenue streams is increasing amongst investment buyers.

Furthermore, money market expectations point to the Bank of England base rate falling sharply over the next 18 months, a positive for a recovery in sentiment towards companies in the real estate sector that have been growing rental income from quality tenants during the hiatus in the investment market in the past two years. For instance, economists at the International Monetary Fund (IMF) predict UK interest rates could fall to 3.5 per cent by the end of 2025, implying a 1.5 percentage point cut from current levels.

In addition, RESI’s niche residential sub-sectors are both likely beneficiaries of a more benign UK government policy that should attract capital flows to the affordable housing sector, and bring its conservative valuations into keener focus, too.

So, having suggested buying RESI’s shares, at 51.3p, less than two months ago (Alpha Research: ‘A high yield property play’, 12 August 2024), and banked last month’s 1.03p-a-share quarterly dividend, which underpins an attractive 7.1 per cent dividend yield, I continue to rate the shares a solid income buy with likely significant capital upside thrown in for free. Buy.

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