UK Commercial Property REIT 05 December 2022

UK Commercial Property REIT (LON:UKCM) is intended to offer exposure to a portfolio of high-quality commercial property which is tilted to areas being supported by structural developments in the UK economy. Two key trends expressed in the current portfolio are the growing importance of logistics and distribution properties to modern economies, and the critical importance of high ESG standards to owners and occupiers.

Lead manager Will Fulton and the board have tended to take a prudent, cautious approach, which means UKCM has one of the lowest levels of Gearing in the peer group. Debt is largely fixed, with a low blended interest rate of 3.16%. These are strengths in a troubled environment for property, such as the one we are in.

Property values took a hit in Q3 2022 as the impact of higher interest rates and gilt yields began to be felt in valuations. UKCM has been hurt by a high exposure to the industrials sector, which was the lowest yielding entering the crisis. Will thinks the outlook for rental growth is still strongest in this sector, which could support UKCM’s dividend through any recession. In fact, a number of significant regearings of leases and rental uplifts were achieved during the quarter even while capital values fell (see Portfolio).

UKCM’s dividend was 96.9% covered for the year to 30 September 2022, with the revenue cover shrinking in Q3 following some exceptional costs, an increase in the cost of the floating rate debt and the sale of an income-generating asset during that quarter. However, new income is due to come on stream in this quarter and the next from assets that have been in development, which should repair some of the gap. Annualising the latest dividend, the yield on the current share price is 5.6%. As markets have reacted to rising interest rates, UKCM has been pushed onto a wide discount of 40.1%.

The immediate outlook for capital values in property is not good, with the consensus amongst the managers we speak to being that there will be further falls to come. This is because property markets operate with a lag, and will slowly incorporate the significance of higher interest rate expectations. However, we believe investors turn to commercial property for income, and if there is a path to the restoration of capital over the medium term, then UKCM’s dividend yield of 5.6% with the potential for growth over the medium to long term looks attractive.

Calling the bottom of the market is fraught with danger and we would not attempt it. However, we believe that when inflation has decisively peaked and expectations for interest rates start to fall, then valuations should turn positive. In the meantime, UKCM has some features which should make it more resilient than peers: a focus on high-quality assets, comparatively low levels of gearing, and strong operational characteristics entering the current recession of 99% occupancy and 98% rent collection . We note that a 40.1% discount to NAV already prices in a fall in the ungeared NAV of c. 33%.