Other than the results from the big names in the sector, the theme of the past few weeks seems to have been fundraising, especially in the alternative space. This has been an encouraging trend and shows there is life beyond the prime office and retail sectors.
First of all we had Tritax Big Box REIT raising another £350m. This was scaled up from the initial target of £200m. Apparently, the share issue was oversubscribed even at that size, so investors still had to be scaled back. This has been an amazing success story since its IPO in 2013 and the market capitalisation of the company is now over £2bn.
Following BBOX we have had the launch of IPOs in social housing, long lease commercial and the private rented sector. Together they were looking to raise £550m from investors. We even had a further £100m preference share raise from Raven Russia. One for the adventurous you might think, but existing investors include Woodford, Old Mutual and Brooks Macdonald.
In the private rented sector PRS REIT (PRSR) raised £250m in its IPO and was ‘significantly’ oversubscribed above that. Apparently demand was close to £400m, so the shares now trade at a premium of nearly 7% above the issue price. Management said investors included some of the UK’s leading institutions, as well as private investors. A placing programme will allow the company to issue up to 250m additional shares over the coming year, so expect further fundraising in due course.
The objective is to generate income and capital growth by investing in newbuild, residential rental sites with multiple units. PRSR is targeting a dividend yield of 6% or more and total shareholder returns of at least 10% after stabilisation, with a target yield of 5% in the first year to June 2018. The returns will be driven by rental growth and occupancy, as well as the yields used to value the portfolio. The company will use gearing of up to 45% LTV.
The units will mainly be family homes, located in the main English cities outside London, let on shorthold tenancies to qualifying tenants. The assets will come with ten-year National House Building Council warranties, so there will be little need for capital expenditure and a low cost maintenance regime in the early years. A pipeline of over 2500 new homes with a value of about £375m has already been contracted, including a portfolio of £72m, which is either completed or under construction.
So far so unremarkable. However, the REIT was given a head start from the government’s Homes and Communities Agency, which has taken 10% of the issue as a cornerstone investor. That certainly boosted its chance of success. What was just as important, I suspect, was the experience and pipeline of Sigma Capital in the PRS space, given the target of building one of the largest PRS portfolios in the UK.
Sigma Capital is an AIM-quoted developer and urban regeneration specialist, which is one of the leading providers of PRS properties in the UK. It has developed and let over 1100 homes in the last two and a half years. Sigma PRS Management, a subsidiary of Sigma Capital, will be the investment advisor.
The investment advisor will source the investments and manage the assets day-to-day, but basically the product will come from Sigma Capital’s development pipeline. This is a very neat exit solution for the parent, which now has a ready buyer for all its developments. I have always been very impressed by the management of Sigma Capital, so I am sure they will make a success of the vehicle.
We all know about the supportive backdrop for the PRS sector in the UK. There is structural undersupply of housing in the UK and huge demand for rental homes. The market for family homes is particularly undersupplied. With affordability levels now the worst in the OECD, tighter mortgage availability and population growth, the PRS market has grown strongly. There is apparently a £17bn pipeline of rental stock and a forecast requirement of £300bn over the next five years. By 2020 PRS is expected to grow to 25% of all households, from 19% currently. This should be boosted by the decline in the buy-to-let market, which is being hit by government tax changes.
Although it claims to be the first REIT to focus purely on the PRS sector, this isn’t strictly true. There have been two previously and one is still listed. Grainger is also becoming more of a PRS play under its new management. Nevertheless, neither of the other two REITs, which admittedly were minnows compared with PRSR, were able to raise anywhere near the level of capital that PRSR has. In the case of K&C REIT it is still not entirely clear what the strategy is and its market cap has been stuck at just £3-4m.
The success of the PRSR IPO continues the recent trend of investors looking to spread their property exposure into specialist and alternative property sectors. The build-to-rent sector in the UK is still new, but has been attracting increasing attention from institutional investors. I know that many have been looking for a way of playing the PRS sector in the listed space for some time.
It looks like they have finally found one. Whether it can really achieve dividend yields of over 6% remains to be seen. That has been the big challenge for PRS REITs previously, because of the gross to net leakage reducing the net rental margin. Either Sigma Capital will have to sell the assets at a discount to allow PRSR to achieve higher net initial yields. Or the property operating costs will have to be so low that the net rental margin is c. 90%, rather than 75-80% as we have seen in the past.
The trade-off for Sigma Capital as the vendor is that it knows it has a willing buyer of its product. So it may well be happy to accept a lower price to secure the forward sales, as this will obviously release cash to invest in future developments. At the same time it makes the investment advisor’s job pretty easy.
It will be interesting to see how it fares. I for one will be watching it with great interest.
