Results analysis: Picton Property Income

• Over the six months to 30/09/2023, PCTN’s property total return was 1.0%, ahead of the MSCI UK quarterly property index’s total return of -0.5%. PCTN’s net assets decreased 1.9% to £537m, or 99p per share. The like-for-like property valuation declined 1.2% to £757.1m.
• PCTN paid dividends totaling £9.5m, or 1.75p (Six months to 30/09/2022 : 1.75p) which were 105% covered.
• The portfolio has a net initial yield of 5.0% and a reversionary yield of 6.8%. At 30/09/202 3 the difference between estimated rental value (ERV) and passing rent is £13.2 million; of which £5.9 million comes from vacant space, £2.8 million from under-rented property, and £4.5 million from the expiry of rent free periods and stepped rents.
• The team secured further planning consents to convert 30,000 sq ft of office space at Angel Gate into residential units, have exchanged contracts to sell a vacant office in Cardiff for conversion to student accommodation and submitted an application to convert part of the Charlotte Terrace W14 office asset to residential. As a result office exposure has fallen from 31% to 26% with Angel Gate and Cardiff both reclassified as alternative use.
• Gearing is 28% LTV. 93% of PCTN’s debt is fixed rate, and the average interest rate is 3.9% and the average maturity is 7.8 years. PCTN’s debt measured at fair value would add 6 pence per share to the net asset value.
• Separately to the results, on 08/11/2023 PCTN confirmed that it was in discussions with UK Commercial Property Trust (UKCM) about a possible all-share merger on an EPRA NTA to EPRA NTA basis. The statement concludes by saying “Under the terms of Picton's proposal to UKCM, the combined company would be internally managed. There can be no certainty that an offer will be made. A further announcement will be made in due course.”
• Chief executive Michael Morris said “Picton has once again outperformed the MSCI UK Quarterly Property Index. We continue to operate with a covered dividend and have a robust balance sheet comprising predominantly long-term fixed rate debt. Our exposure to the better performing industrial sector has supported the overall portfolio valuation while we’ve made excellent progress with our plans to find alternative uses for some of our office assets. We’re also continuing to progress a number of asset management initiatives aimed at capturing the reversionary potential in the portfolio, we have scope to grow annual rental income by letting £5.9 million of vacant space and by resetting rents to market levels providing a further £2.8 million per annum.”

Kepler View

While rising interest rates and the consequent shift in sentiment to property as an asset class largely account for the wide discount to net asset value Picton Property Income (PCTN) and its peers trade at, in PCTN’s case a c. 35% discount to its headline NAV, PCTN’s results provide a reminder of some key strengths of this self-managed REIT against this backdrop. First, 93% of PCTN’s debt is fixed, with an average maturity of 7.8 years, so there is very little pressure on dividend cover from rising debt costs and in the first six months PCTN maintained its record of paying a covered dividend with 105% coverage. At the current share price PCTN yields 5.4% assuming it continues at the same run rate for the second half of the year.

Secondly, not all property sectors are the same. Underlying   the overall property valuation decline of 1.2%, PCTN’s industrial assets, almost 59% of the portfolio, showed a positive valuation change of 0.9% and the retail assets, c. 10%, declined by just -0.4%. Industrial and logistics assets are still in a state of high tenant demand exacerbated by a shortage of supply, with very little speculative development over many years. The main weakness was, unsurprisingly, in PCTN’s office portfolio, which is c. 31% of the portfolio and declined by 5.3%. The offices sector is a source of great debate in the property world and of course not all offices are created the same, but what seems clear is that there is an excess of supply. Michael and the team have various active management initiatives in progress, with the two most significant noted above, Angel Gate and Cardiff, likely to reduce office exposure from 31% to 26%. This will be achieved by actively seeking alternative uses which have the potential to create more value than by simply reducing exposure by selling assets.

Third, PCTN has significant reversionary potential, with its reversionary yield at 6.8% compared to its net initial yield of 5.0%. Again, this means that active management has the potential to make a significant contribution to PCTN’s dividend cover. As the figures summarized above show, the reversionary potential comes from different sources, both from vacancies, but also from rent free periods and from some properties currently let at rents below their current ERV.

Overall then, while the direction of interest rates will continue to have a significant influence, Michael and the team have a number of levers that they are already pulling to increase the rent roll and to stabilise and improve valuations, and PCTN’s direct exposure to rising interest rates is limited by its largely fixed debt.

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