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Dramatic rises in interest rates and inflation over the past couple of years have had an equally dramatic impact on Regional Reit, one of our Income Portfolio’s property funds.
Rising interest rates have hit the trust, whose assets consist largely of office buildings outside the London area, in three ways.
First, property values have suffered as returns on cash and bonds have risen; in order for yields on property to remain competitive, prices have to fall.
Second, the trust, like almost all property funds, has borrowed money – and Regional has borrowed more than most. While it has very sensibly fixed the interest rate it pays on much of its debt, just as many prudent homeowners do, sooner or later those borrowings will have to be refinanced and Regional is therefore trying to reduce debt by selling properties. Unfortunately that also means less rental income.
Third, other costs have risen as inflation bites. For example, the expense of cleaning and maintaining unlet properties falls on the trust and these costs have risen sharply. Rates also have to be paid on empty buildings.
There’s not much the trust can do about a higher Bank Rate and its effects on asset prices. It has already taken sensible steps to cap its own interest bill and is preparing for an eventual rise when existing borrowings expire by trying to cut debt through those asset sales.
The key factor over which it has control is the level of vacancies, which stands at about 21pc of its available property (some is undergoing improvement or is otherwise unavailable to let).
The rise in the costs associated with unlet space, such as rates and cleaning, has made the vacancies a key problem for the trust.
“We absolutely believe we can get back to pre-pandemic levels of vacancies of about 13pc,” Stephen Inglis, the head of Regional’s management company, told Questor yesterday. “How? There are two ways to do it – sell buildings with too much vacant space or find tenants for that space – and we are doing both.”
He said reports of the death of office working had been greatly exaggerated, especially when it came to offices outside London.
“It’s easy to forget how recently the pandemic really ended,” he said. “In March last year only 30pc of our tenants had any staff back in the office. By November 99pc had some employees back in some form. This year our tenants’ staff spend an average of 4.2 days in the office.”
The effects can be seen in the demand for office space, itself reflected in the fact that when a new lease is signed the rent typically rises.
“Last year was a record leasing year for us,” Inglis added.
Sales of offices are also taking place at encouraging prices. The trust announced yesterday that it had sold a building in Glasgow for 26.3pc more than the most recent valuation at June 30.
Inglis said office buildings were often worth more if the site was converted to another use and “nearly all the buildings we have sold in recent years have been for an alternative use”. But valuations in the trust’s books are based on the continued use of its assets as offices.
Yesterday Regional also said it would maintain its next quarterly dividend at 1.2p.
At the current share price, that equates to a yield of about 17pc, which is obviously unsustainable. The market is saying that further dividend cuts after the one earlier this year are on the way but brokers have said they believe a divi at or around current levels should be sustainable.
If this is case the shares are severely mispriced and a strong recovery will follow sooner or later. While our portfolio’s paper loss of 72pc in capital terms is clearly unpalatable it would not make any sense to sell at such distressed levels, especially if the income looks reasonably secure. We’ll hold on.
Questor says: hold
Ticker: RGL
Share price at close: 28.55p
Update: Murray International
This global equity income fund, which has been a solid if unspectacular performer for our portfolio, is to have new managers after the veteran investor Bruce Stout said he would step down next year.
Two of his long-standing colleagues, Martin Connaghan and Samantha Fitzpatrick, have already been promoted to co-manager and will take over full responsibility for the portfolio when Stout leaves.
The chairman said this would ensure “the smoothest of handovers” and there would be no change in approach to the fund’s investment management.
As ever in these situations we will hold on but keep an eye on what happens after the change of management and be ready to act if need be. Hold.
Questor says: hold
Ticker: MYI
Share price at close: 235p
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