Custodian Property Income REIT (LON:CREI) reported a 2.5% NAV total return for Q325, driven by income but with NAV also increasing. Portfolio values increased for the second consecutive quarter and, with a robust occupier market driving rent growth, the company is increasingly confident that the market is at or near an inflection point.
CREI yields 7.8% and its portfolio has significant opportunities to further increase income and fully cover DPS. The prospects for capital growth also appear increasingly positive.
Note: EPRA earnings exclude revaluation gains/losses and other exceptional items. NAV is defined as EPRA net tangible assets (EPRA NTA) throughout this report.
Rental Growth with Strong Potential
Q325 NAV per share increased 0.9% to 94.4p and, including DPS paid, the NAV total return was 2.5% (year to date 6.1%). Like-for-like portfolio gains were 0.5%, similar to Q2. Rental values have continued to increase and through active leasing are increasingly reflected in passing rent and income. DPS is well on track to meet the 6.0p FY25 target (+3.4% y-o-y) on a fully covered basis. With ERV of £5.0m or 11% above passing rent, there is significant income potential. Gearing is moderate (LTV of 28.5%), mostly (82%) fixed rate but positioned to benefit from declining interest rates. We have made no changes to our forecasts for growth in EPRA earnings and DPS, but have increased FY25e NAV by 0.7p to 94.9p, with a similar uplift to FY26e.
Diversified and Differentiated
Across most of the UK commercial property market, but especially the industrial sector, robust occupier demand has underpinned rental growth. Meanwhile, sector values are down c 20% from their peak and, with interest rates now declining, investment market sentiment is improving. CREI provides investors with the opportunity to access a sector recovery through diversified UK commercial property exposure, within a closed-end fund structure. It is differentiated by an enhanced income strategy that targets higher-yielding, smaller regional properties, with strong income characteristics, led to predominantly institutional-grade tenants. Income risk is spread across a wide number of properties and tenants, the vast majority of which are externally classified as having better-than-average risk. Although diversified, the portfolio is not passively positioned and is actively managed, currently with a strong weighting towards the well-performing industrial and retail warehouse sectors.
Attractive Dividend Yield with Capital Upside
Dividends are fully covered and CREI’s FY25 DPS target represents an attractive yield of 7.8%, with the potential for capital growth. While the 17% discount to NAV is lower than for some peers, the potential for investors to benefit from narrowing remains.
Rents and Rental Income Are Continuing to Grow
All on a like-for-like basis, the portfolio estimated rental value (ERV) increased 0.6% in Q3 and is up by 2.1% year to date. Reflecting active letting and lease renewal activity, passing rent increased 0.9% in the quarter and by 3.1% year to date, led by the industrial sector (+1.0% in Q3/+4.7% ytd). During the quarter, CREI completed 26 lettings, lease renewals, re-gears and rent reviews at significant average premiums to ERV and/or previous rent. Considerable reversion remains, with £5.0m, or 11%, potential upside from passing rent of £44.5m to ERV of £49.4m. Around 35% of this reflects the upside to market rents that CREI expects to emerge with rent reviews (typically five-yearly) and re-letting of current occupied space, and the balance from letting vacant space. End-Q3 EPRA vacancy was 6.6% of ERV, of which 1.8% of ERV was subject to refurbishment or under offer.
With EPRA earnings mostly distributed, the movement in NAV, in Q325 and year to date, is driven by the property valuation movements.
Exhibit 1: Quarterly NAV Progression
Source: Custodian Income REIT data, Edison Investment Research
CREI’s portfolio valuations stabilised in Q424 and Q125 and have been positive in both Q2 and Q3, reflecting rental growth and other asset management initiatives alongside a more positive tone to the market. CREI’s large industrial asset weighting continues to have a positive impact on the portfolio valuation performance, consistent with the broad UK property market trend. However, the retail warehouse and high street retail assets have shown an even greater increase, while the office assets are the only area where valuations have continued to decline.
Exhibit 2: Portfolio Summary and Valuation Movements
Source: Custodian Income REIT data, Edison Investment Research
CREI Is Increasingly Optimistic About Future Sector Performance
CREI points to the disconnect between the direct property market, benefiting from robust occupier demand and rental growth, and the listed sector, where concerns over the economy and volatility in the government bond market continue to weigh on investor sentiment. The most recent survey of direct market participants undertaken by the Investment Property Forum, with data gathered between the end of September and mid-November, highlights the consensus expectation for rental and capital growth across all sectors over the next three to five years. The industrial and retail warehouse sectors, representing 72% of CREI’s portfolio, are expected to show the strongest total return. The all-market 2024–28 consensus expectation for total return is 7.5% pa.
Exhibit 3: Investment Property Forum Consensus Forecasts (Autumn 2024)
Source: Investment Property Forum
Capital Recycling To Fund Accretive Capex
The company has continued to dispose of non-core property, at a premium to book value, providing funding for accretive capital expenditure. During Q3, a vacant office property was sold for £1.4m at a 33% premium and capex amounted to £1.9m. Capex is improving the quality of the portfolio, including energy efficiency, enhancing the attractiveness to occupiers. CREI says that where investment is required, it is being reflected in greater tenant demand, additional rental growth and, increasingly, in valuations. All ongoing capital works are expected to enhance the valuations of the assets and, once let, increase rents to give a yield on cost of at least 7%.
Moderate Gearing and Refinancing Requirements
End-Q3 borrowings were £171m, from total facilities of £190m, or £215m including an accordion option at the discretion of the lender. The net loan-to-value ratio was 28.5%. Drawn borrowings comprised £140m (82% of the total) of long-term, fixed-rate debt at a blended interest cost of 3.4%, with a six-year average maturity and £31m of floating rate debt drawn from the company’s revolving credit facility (RCF). The weighted average cost of aggregate borrowings was 3.9%. The first debt maturity, a £20m fixed-rate facility with Scottish Widows, will mature in August 2025 and the company intends to repay this by drawing further on the RCF. The £50m RCF facility was extended by three years during FY24 and can be increased to £75m under an accordion facility, subject to lender approval. If interest rates decline in line with market consensus, given the modest size of the facility, the impact on CREI’s borrowing costs would be minimal. At the time of writing, the UK five-year swap rate is a little under 4%, providing a benchmark for refinancing at current market levels, to which a lending margin of perhaps 2% should be added.
Valuation
CREI’s 6.0p target DPS for FY25 represents a prospective yield of 7.8%. Meanwhile, the shares trade at an 18% discount to the Q325 NAV per share of 94.4p. These are similar ratios to the average of the peer group. Within this, CREI is differentiated by its greater focus on income and fully covered, dividend-led returns, underpinned by its targeting of smaller lot-size properties, with a premium yield, and attractive risk-adjusted income returns.
Over one and three years, the peer group has outperformed the wider property sector but has underperformed the broad UK equity market, very substantially so over three years. CREI shares have outperformed the peer group but have experienced a relative de-rating over three years.
Exhibit 4: Peer Valuation and Performance Summary
Source: Company data, Edison Investment Research, LSEG Data & Analytics prices as of 5 February 2025. Note: *Based on last reported EPRA NAV/NTA. **Based on trailing 12-month DPS declared.
Exhibit 5: Financial Summary
Source: Custodian Property Income REIT historical data, Edison Investment Research forecasts