Custodian Property Income REIT (LSE:CREI) — Investor Presentation

0:00 Good morning, and welcome to the CUSTODIAN PROPERTY INCOME REIT PLC Investor Presentation. Throughout this quarter presentation, investors will be in listen only mode. Questions are encouraged, and they can be submitted at any time via the Q and A tab situated in the right corner of your screen. Just simply type in your questions and press send. The company may not be in a position to answer every question received in the meeting itself, but the company can review all the questions submitted today and publish responses where it's appropriate to do so. Before we begin, I'd like to submit the following poll. I'd now like to hand you over to Richard Sheppardcross, managing director. Good morning, sir. Good morning. Thank you, Alexander, and good morning, everyone. Welcome to this update. Some of you may have heard me speak before, so forgive me if I am a little repetitive, but I'm going to work on the basis that there are others for whom CUSTODIAN PROPERTY INCOME REIT is new.

0:56 So starting at the top, what do, what does CUSTODIAN PROPERTY INCOME REIT set out to do? Well, it aims to be the REIT of choice for private and institutional investors seeking high and stable dividends from well diversified UK real estate. And while that's a mission statement, there's a lot in there. We are a proudly diversified fund, and we are very income focused. And we think particularly well suited, to both, private investors, but also to, institution investors. There's a real opportunity in the market at the moment, and it has been caused by various factors.

1:46 One, the sharp fall in property values following the increase in interest rates in 2022, allied to the enormous geopolitical and more locally political distraction that has been caused by Trumponomics, by the chancellor's growth agenda that has kept people in a reasonably volatile state, and that has meant they've overlooked the real opportunity that has been building in commercial property. And perhaps no way better to look at that than through a good old fashioned SWOT analysis.

2:36 So the strengths of the market, I think it is it has been overlooked that in the year to March 2024, UK commercial property delivered a total return of 7.7%. And I think that would fly in the face of some people's expectations who still saw property as a risky asset through those twelve months. And as we look forwards, and we'll look at this in a bit more detail in a moment, forecast total returns for the next four to five years is over 8% per annum. And the real driver of this performance is and has been rental growth. And rental growth is what you should be looking for in any property investment.

3:24 And we're seeing it coming through very strongly across really all sectors of the property market, both industrial and logistics, which has been the mainstay of rental growth for the last few years, but it is also now in the office sector, in retail, particularly in retail parks, so out of town retail, but also in prime high streets, and that has been driving performance. The opportunity is that because everyone has been looking the other way and because money has not been committed to listed real estate investment, it is possible to buy into stocks like custodian property income REIT and get a dividend yield of around seven and a half percent.

4:13 And that is comfortably higher than long term averages would suggest, and it is simply because there isn't enough focus on on the sector at the moment, and stocks have moved to a discount to net asset value creating that very attractive entry point. The limited supply that continues to drive rents has been further exacerbated by, two to three years of uncertainty since interest rates started to rise, which means there hasn't been a great deal of new development. So the pressure on rents is going nowhere. We are still seeing that supply demand imbalance that is driving rents forward.

5:00 And we're also now seeing that there's a real rental premium for those landlords who improve the environmental credentials of their buildings, which is certainly been central to our asset management strategy over the last number of years, many years, in fact. The weakness is really centered around the cost of money, and this is a this is a sort of a a a twin story. At the long end, we're seeing long term bond rates are high, and we are, you know, not expecting to see those short a change in the in the immediate term.

5:49 We're seeing, at the short end, interest rates falling, and that is good for people buying property with debt. It is also good for a business like ours because as our variable rate debt becomes cheaper, so it creates further headroom for earnings to cover dividends. But the long term rates being so stubbornly high suggests to me that we won't see yield compression in commercial real estate because, for as far back as you, want to look, there has been a direct inverse correlation, between long term bond rates and commercial property yields.

6:35 So I'm not expecting to see capital values growing on the back of yield compression. But what I do expect to see is that capital values will grow as rents grow, and that's good growth because that's nailed on growth. The sort of threats we're seeing are, as I touched on, they're the geopolitical threats, and in our own political system, the uncertainty, and, disquiet that that is creating amongst investors. Those are the threats that we face, not really property specific threats. I've been saying for some time that there is opportunity, an interesting time to invest in commercial property.

7:22 And this is because I'm looking at the underlying real estate. And that's what this chart is showing is the performance of underlying real estate over this five year period. In light blue, you can see those bars, the very consistent dividend income, income return that comes from real estate, and in the dark blue, the movement in capital values. So firstly, the impact of the pandemic, you saw values fall. We then saw an extraordinary period of recovery immediately post pandemic. And in fact, the market got carried away. And all it really meant is that we were going to fall back from a higher height when interest rates started to rise as they did in 2022, and you can see that sharp correction, in 2022.

8:10 But what is interesting and I think has been overlooked is that capital values have been growing now or certainly, they've certainly been flat or growing for nearly two years, with with more meaningful growth through the last twelve months. And that hasn't really been picked up by investors. If we look forwards, this is the Investment Property Forum's consensus forecast of total returns from real estate. This is whole market data. The Investment Property Forum is made up of all the main players in the market from banks to institutions to property agents to developers. They all combine to this consensus forecast.

8:58 And what it demonstrates is yet again that very consistent income return that comes from real estate, but with positive capital growth. And I suspect that most of that is being driven by underlying rental growth. And that's why we're getting such a consistent, total return around about 8% for the next, five years. Now current share prices are not reflecting this consensus forecast. If you were to look at current share prices, you would still think that real estate investment was high risk when, in fact, it is offering very stable income centric returns. And there are two groups of investors that have really caught on to this opportunity. One is retail investors, and this is looking at our own shareholder register and the increase in retail investors through the typical investment platforms, Hargreaves, Landsdon, AJ Bell, Interactive Investor.

10:04 And the significant increase we have seen of money flowing onto our shareholder register from those retail investors. Over 30,000,000 over this period, but you can see that very steep increase as retail investors see the opportunity that exists in The UK. And I think we've got we've got a situation where, for a very long time, the standard and acknowledged investment theory was to buy growth stocks, particularly US growth stocks and even more particularly, US tech stocks.

10:50 And that has proved to be very successful over an extended period. But I would question now whether a reeducation isn't required. And I think that retail investors have reeducated themselves to the opportunity of UK value stocks, and there is nothing more UK than UK real estate and nothing more value than a seven and a half percent dividend yield with rental growth potential. So I think it's gonna take a while for the supertanker that is the institutional investor to turn around and and reconsider the opportunities that exist in UK real estate at the moment.

11:36 The second group of investors who have been active in listed real estate have been has been private equity. Now private equity isn't known for calling the market incorrectly. They tend to invest when they see real opportunity. And we have seen private equity and very active in listed real estate market, either in mergers and acquisitions or take privates. And of all the transactions you can see on the screen here, the deals have been done at an average 10% discount to net asset value. Why is that important? It's important because they see opportunity at a 10% discount.

12:24 The market is pricing all of listed real estate at around a 30% discount today. That's a huge mismatch between those that have money and see an opportunity that think a 10 discount is the correct price versus the market as a whole as a result or as a result as a result of lack of demand trading at a 30 discount. So I think two, key sectors have seen the opportunity. Institutional money hasn't picked up on that yet, and that is that means that the opportunity to invest now at these very generous dividend yields, that window is remaining wide open.

13:11 So a bit more about custodian property income REIT in detail. What do we aim to achieve? We aim to provide exposure to well diversified regional UK real estate within an institutional grade package. We are unusual in that we target smaller regional properties, so typically below 10 to 15,000,000. And we do that for a number of reasons, not least because there is less competition from institutional money, which tends to have a lower cost of capital and therefore can afford to pay higher prices. But also because it means we end up with more properties in the portfolio, which adds to diversification. And as I'll show you in a couple of moments, we think there is a real mismatch in in values that provides a higher income return from this property strategy without adding to risk.

14:10 The portfolio currently supports earnings of 6p per share, which pays a fully covered dividend. And as I said, based on the current price, that's a seven and a half percent dividend yield. Yet we have a portfolio with a rent roll of 44,900,000 and an estimated rental value of 51.4. So 14% reversionary potential, which will support future dividend growth and the rising cost of debt over time. Just looking at this is the, in fact, the quarter to the end of June. Our September trading update comes up very shortly, so do watch out for that.

14:58 But what what it shows you, and I think it'll be a pretty consistent story in our next announcement, is positively across the board. Through the quarter, 10 new lettings, three new lettings of vacant space, which added nearly a million pounds to the rent roll where we agreed new leases. We were agreeing those at 8% ahead of our value as estimate of rental value. So that 14% reversionary potential might even be underplaying the the the real fact. As I said, significant rental growth potential to come through. And and of that 14% reversionary potential, 30% of that will come from existing lease events. So reletting existing space, rent reviews, and the other 70 will be from letting up vacant space.

15:50 Vacancy has been around 10%. Expect to see some improvements in our next announcement based on recent asset management activity. Two rent reviews were agreed in the quarter. Both showed an average 25% increase. So these are really very positive figures. We were able to sell properties ahead of net asset value, which caused him to question net asset value as a measure of worth. And I think it creates a lot of problems in the listed real estate sector that net asset value seems to be the benchmark measure of worth. I would counsel anyone, to not completely ignore net asset value, but not use it as my lead indicator of worth, instead to look at earnings.

16:43 That's really why we all invest our money. We want our money to earn a return, and property does that better than most with long contractual leases providing rent that supports earnings that pay dividends. It's really a very direct connection. And I think it is the right way to consider the relative worth of one real estate investment trust versus another. I would look more closely at earnings and less at net asset value. But net asset value, not completely obsolete. It still demonstrates the underlying health of the portfolio, and we've been delivering positive net asset value growth in nearly 10% over the year.

17:37 I said rental growth was the biggest driver of performance, and you can see in this chart the the dark blue line is the rental reversion, that is that has flowed through, really from 2021 until today. So sitting at about a 14% reversionary potential. The light blue shading shows how we've picked that rental growth up over time. We have managed through this period of growth also to bring down loan to value from nearly 30% to 26.9% today. And that has been accretive to earnings because we've been able to pay down some of our variable rate debt, which is relatively more expensive.

18:31 In terms of the shape of the portfolio, it's been very consistent. We are focused on those sectors of the property market where we see the most rental growth. So retail, warehousing, which makes up 22% of our portfolio, and industrial and logistics, which makes up 43% of the rent roll. But it important to remember, we are actually seeing rental growth in all sectors across our portfolio at the moment. This chart really demonstrates why we, pursue that smaller regional property strategy, and it looks very simply at whole market data going back twenty five years. In the dark blue line is the net initial yield of properties that have traded with a lot size of under 10,000,000 and the light blue over 10,000,000.

19:22 You can see there has been a consistent and sometimes very wide margin between those two. But it's not a it's not a, it's not driven by risk. It's driven by supply and demand. There are more investors looking for relatively large, relatively prime assets, and prices reflect that. And there are fewer investors looking at the smaller regional properties, and that has created a a very meaningful margin. That higher margin allows us to pay a higher dividend, and it has also delivered lower volatility over the last few years as interest rates have bitten much harder on those lower yielding assets than they have on the the typically high yielding assets that that we buy.

20:14 The spread of the portfolio, you know, when we talk about diversification, I think we do this more seriously than anybody else. Very broadly spread portfolio. And this chart shows you how broadly diversified our rent roll is. Each of the slices of pie in the chart show the amount of rent paid by any one tenant. And even amongst our largest tenants, which we've broken out on the left hand side, there is further diversification because for INCOME, we have eight properties spread across the country. And all of this means we've got no single property, let to only one tenant that represents more than 1.8% of the rent roll. So really very broadly diversified.

21:07 One of the, challenges that is sometimes, put to us is, well, if you own all these small properties, then presumably you have, weaker tenant covenants, and that's simply not the case. One of the beauties of looking at a a nationwide portfolio of smaller properties is there's an awful lot to choose from. And we particularly choose those properties that are in the best locations, first rule of property investment, but in good quality, fit for purpose buildings, and typically let to the very best tenants in those locations. And this chart looks at the Experian credit rating of our tenants, which shows that 85% are considered lower than average risk. So just to summarize that, good quality tenants, broadly diversified, diversified by sector with rental growth.

22:06 And for all that risk mitigation, you can get a seven and a half percent dividend yield. That feels like an opportunity to me. One of the one of the strategies we've pursued recently in order to grow because we think this is a great time to grow because real estate is, we think, very good value. But we are finding it difficult to grow through new share issuance because we're trading at a discount to net asset value. We have instead looked at, acquiring, property portfolios with shares rather than with cash, in what we call an all share, acquisition.

22:52 And the the deal we completed a little earlier this year was the acquisition of Merlin Properties. This was a £22,000,000 portfolio. It was diversified in all the right sectors and in locations that we knew well. And the driver for the family to sell this portfolio was principally around succession. Three brothers who had built the portfolio up were all in their seventies. They had children who didn't want to take on the management of the portfolio, but partly because of age and the need for succession, partly driven by inherent tax pressures, partly driven by capital gains tax pressures.

23:43 They were keen to move assets down through the family. And not easy to do when you have a portfolio of assets that are, by nature, lumpy, and you don't really wanna pass them down to the next generation if they don't want to manage them. So by us acquiring the portfolio and giving them shares in custodian property income REIT, they were able to convert that lumpy property portfolio into an equitably divisible asset, shares in custodian property income REIT, which we're then able to pass down through the family. That also enabled them to improve the income security from a much more diverse professionally managed portfolio.

24:30 But importantly, this transaction was very tax efficient. As we acquired the corporate entity, we paid no stamp duty land tax. As a real estate investment trust, we don't pay corporation tax. Therefore, the chargeable gain that have been built up in Merlin Properties over thirty years as asset values have increased got extinguished on transfer. So that was a significant saving. And the underlying shareholders of Merlin Properties were able to get a holdover relief on the CGT that they've built up on their shareholding in Merlin by rolling them into custodian property income REIT. So very tax efficient strategy. We now have a significant shareholder on our register in the family that were behind Merlin who were long term investors. This for them was not an exit, but it just resolved lots of issues. And we think there are tens of dozens of opportunities of this type that would suit our portfolio particularly well, enable us to add assets at a low point in the valuation cycle, which will support ongoing dividend growth for our shareholders.

25:48 We also announced over the summer a share buyback, and we did this particularly because the maths had all changed. From 2022 onwards, the most efficient thing we could do with sale proceeds was pay down variable rate debt because that was more expensive than meeting the cost of our dividends. Those dynamics turned around this year with our share price at a position that it's an effective dividend rate of seven and a half percent. Cost of debt had fallen to below 6%. So it was more accretive for us to use sale proceeds to cancel shares and cancel that seven and a half percent dividend while mildly increasing gearing when gearing was only 5.7%.

26:42 So it's it was a small buyback, about 5,000,000 to be used between August when we made the announcement and the end of the year, and it's really there to take out some of the volatility on the downside with when there is slightly higher than normal selling pressure. My expectation is that the opportunity that I've set out and that we see will be picked up on in the New Year. Unfortunately, in advance of the budget, I think we're gonna see no change. Between the budget and Christmas, I think people will be otherwise engaged. And as we come into the new year, January tends to be a quiet month, so it might not be till February next year that we start to see the opportunities that I've set out really move to meaningful, movement in share price.

27:36 And we will then reconsider whether the the buyback, is, it's necessary to continue with that. So to conclude and before I move to questions, there's a real opportunity to capitalize on the discount that is generating, you know, now seven and a half percent dividend yield based on the current price, lock in that high dividend. And in some ways, I see this as a two way bet. If you are an income investor, then a seven and half percent dividend yield is very attractive. If you are focused on growth and we see growth in the market, then you will have seven and a half percent plus growth. If we don't see growth, well, at least you've had seven and a half percent dividend yield. So I think a good two way bet at the moment, and let's follow the example that has been set by both private investors and private equity who've seen the opportunity.

28:47 So that's all from me. And maybe now we'll pick up some of your questions, and thank you for submitting those. I'll I'll I'll read out the questions and then do my best to answer them. The first is around the Merlin acquisition. And the question is that we have provided them with a more liquid investment. Is there not a risk with this and with further deals of this type that they will utilize this new liquidity to just slowly sell into any share price rises and so suppress our attempts to narrow the discount to NAV with buybacks. And that's a very fair point, and it it's not lost on us.

29:36 So when considering investments like this, the very first question to, the property company is, is this an exit event for you, or is this more about succession, and do you remain, long term investors in real estate? If it's an exit, then we this is not the right transaction for us, and we wouldn't pursue it. And indeed, we've considered at least two, subsequent to, completing the Merlin transaction where it has very clearly been an exit event, and we haven't pursued those opportunities. One of the factors that that mitigates against, using, the more liquid, custodian property income REIT shares to conclude and exit is because the shareholders in Merlin roll their capital gain into their shareholding in custodian property income REIT, they now sit with their shares pregnant with capital gain.

30:43 So that discourages them from selling. But but, really, yeah, that that's a yeah. That helps. But the real the focus for us is to make sure that we don't do deals with families that just want to exit, and we are are pretty rigorous in asking those questions. It is also possible with a a share buyback sorry. Excuse me. An all share transaction to do a part share transaction. So if we know they have immediate liquidity requests, much better that we resolve that by paying them part cash and part shares. But in the case of Merlin, that wasn't the case. There was an all share transaction.

31:34 The next question, would a potential increase in business rates on large commercial premises have a material impact on the asset value of this REIT? I think it would have less of an impact on custodian property income REIT because we tend not to own the really large commercial premises. Any change in tax is gonna have an impact on the taxed, and that is gonna have a knock on impact on us. But I don't think we will be unduly affected given the diversity of our portfolio and given the very large number of smaller assets that we have. You know, our average property size is under £4,000,000. I think the the big business rate impacts are likely to hit the much larger assets harder.

32:29 But there's no getting away from the fact that tax impacts, you know, do do flow through. So the next is why do you think there are such big differences in discounts across across REITs, in particular, CUSTODIAN versus one of your main competitors, AEW, which trades at around net asset value? Well, I think this goes straight to the the point I touched on before. Net asset value is a very blunt tool, and it's not a very good measure of worth. If you look at CUSTODIAN and AEW on an earnings yield basis, there's really nothing to split us. We're basically trading on the same earnings yield. So perhaps, the market is better informed than I gave them credit for, and they are considering worth by reference to earnings rather than to net asset value.

33:23 So, fundamentally, that that's the difference here. Both if you were to buy shares in either, you would get around about a seven and a half percent dividend yield. Net asset value, like I said, it's a poor measure of worth. What is our EPRA cost ratio, please? I think latest numbers are are I I would have to double check the EPRA cost ratio, but our our TER is is 1.3%. And the next question, what drives daily fluctuations in the share price, which can sometimes be as much as a few percent without being any obvious driver of this?

34:11 It's just buying and selling. I'm afraid it is as simple as that. We are fortunate in that we have a very substantial core of long term loyal shareholders who have bought CUSTODIAN for long term income and are not looking at the share price on a daily basis, and they are not trying to trade in the stock to make their returns. They bought and hold for income. So the free float is or, you know, the the of the realistic available free float is very much smaller than the total shareholder might suggest.

34:59 So, you know, a small a relatively small amount of selling pressure can have quite an impact, but daily share price fluctuation, it just goes with the territory. I think you need to look at it over a longer period of time. The next question, what is the single biggest threat to the positive overall picture that you are communicating? I think the single biggest threat remains economic sentiment. The underlying drivers of performance in real estate, I think, are pretty much locked in. You we we haven't got an oversupply of property.

35:48 People need, real estate to run their businesses. As we have often seen, following periods of inflation, you expect, and we are now witnessing rental growth. I think inflation is going to remain part of the government strategy to deal with debt. And I think we probably if we're all really look at our own personal level inflation, it doesn't really correlate with CPI and RPI numbers, feels very much higher, and the government are gonna continue to use inflation to inflate their way out of their current debt problem. So while we have inflation, I would expect we will continue to see rental growth.

36:37 You know, real estate tends to protect the real value of the property through rental growth. But, yeah, it is it's it's sentiment more generally that is probably the biggest threat. It's a similar question to one that's been asked before, but I I I will I will put it, anyway. Do you see CUSTODIAN as being differentiated from your main competitors such as Schroederiet and AEW, and what, if anything, are the main points of difference? Well, look, in many ways, we're very similar. Our property strategy is subtly different. Our risk profile, I think, is more broadly mitigated and diversified.

37:26 And we yeah. We've but but but otherwise, there's not a lot to to split the two. Obviously, we're bigger than both showed a REIT and AEW. That gives some investors some comfort, but not not a huge difference. Next question. You haven't mentioned downside risk to the share price. What, in your view, could drive the share price lower? I'm an optimist, and I see a huge mismatch between the share price and underlying property values. Could that grow still wider?

38:13 I mean, of course, it's possible, but it wouldn't seem logical for rents to grow, property values to grow, and share prices to fall still further at than than than they currently are. I mean, if we saw a huge increase in interest rates, which isn't forecast by anybody. But if we saw that, that would have an impact. But it wouldn't seem logical. And the final question, can you comment on the recent recent legislation potentially banning upwards only rent reviews? Just as a as an aside, isn't it extraordinary that this is yet another policy announced by the government without any consultation with the people that really know? And my understanding is there's been no con consultation with the property industry on this.

39:14 My personal view is sort of so what? You know? Typically, our leases are now for five years. So increasingly, they don't have rent reviews. You only get a rent review every five years, so you need a a lease that runs for for ten years for in order for that to be a problem. I'd also say so what because I would prefer that we have properties let at the right rent. It doesn't suit us, and it doesn't suit our tenants for them to be paying the wrong rent. Certainly, not if they're paying too much rent, that doesn't really help anybody. And while you get a short term benefit of slightly higher cash flow, It all comes home to roost at the end of the lease when rents have to rebase to market levels.

40:01 So I think it's I think it's fine. I think the risks might be around lending. The banks are gonna have to get their heads around genuine rental values rather than just accepting the properties less, and there's not that there's only rent review. But that will soon wash through. And I think it it it could end up being perfectly positive. The the suggested rationale that wicked, average landlords have been driving rents up for years and the poor tenants have suffered is a sort of nonsense. Because as landlords, we don't set the rent. The rent is set by market demand. So if you have retailers competing with each other to occupy the very best pitch on the high street, It's the retailers who've driven rents up, not landlords.

40:54 As landlords, we are recipients of market levels of rent. And I think the, the the the rationale that's being given is that this will sort of stop. This sort of greedy behavior by landlords is is sort of ridiculous, but I don't see it being a a major problem. And then another question that's just come in. Any initial thoughts on London Metric taking a nine and a half percent stake in Schroger REIT? Well, I mean, you can all draw your own conclusions. They are very clearly, it would appear to me, gonna make a play for Schrodery, but, I don't know that anymore than any of you.

41:46 I can't see why else they'd be doing that unless they think that their stock is particularly cheap. I think if London Metric was sitting in a lot of cash and they wanted something to do with it, then you might be able to make that argument, but I don't think they are. I think they they are their portfolio is geared. So, yeah, I did watch this space. I I will certainly be watching closely, but I have no insight on that at all. Another question, do you have significant skin in the game yourself? Yes. I do. Certainly significant as far as I'm concerned. My and my wife's entire ISO portfolios are invested in custodian property income REIT, and I can't think of anywhere better to push it. So, yes, I I do have skin in the game.

42:35 I think that concludes the questions. Yes. It does. Well, thank you very much for answering those questions from investors. Of course, the company can read all the questions from us today, and we'll publish the responses out on the investor meet company platform. But just before redirecting investors to provide you with their feedback, Shneur is particularly important to yourself, Richard, could I just ask you for a few closing comments? Yeah. I'll close as I as I closed the the presentation before the q and a. Don't let private investors and private equity have all the fun. There's a real opportunity out there. The window has stayed open for longer than I forecast for the reasons that we've given. But locking in in the seven and a half percent dividend yield feels like it in each way, bet to me, every which way, it looks okay.

43:29 Thank you very much. That's great. Well, thank you once again for updating investors today. Could I please ask investors not to close the session? I should now be automatically redirected to provide your feedback, and all the management team can better understand your views and expectations. On behalf of the management team of CUSTODIAN PROPERTY INCOME REIT PLC, We'd like to thank you for attending today's presentation, and good morning to you all.