Increased asset quality reflected in leasing

During FY24, the like-for-like portfolio value, after adjusting for capex and disposals, declined by 8.1% (3.1% in H2 vs 5.1% in H1). New leasing added £3.2m of annual rents at an average 13.5% above ERV. Lettings showed a seasonal slowdown in Q4, but the premium to ERV continued to increase. Investment in core assets, and exits from non-core properties, are reflected in another year of strong progress on EPC ratings, with c 83% (FY23: 74%) of the portfolio now rated EPC C or better. Occupier hesitancy and significant lease breaks and expiries more than offset the positive leasing in FY24, but these factors should be less of a drag in the current year, and asset management provides scope for occupancy gains. There is significant upside potential from the gross rent roll of £60.7m (FY23: £67.8m) to the ERV of £83.2m. Other than a reduction in EPRA NTA, our FY24 forecasts are unchanged. For FY25e we now show a slower rise in earnings and DPS as RGL invests in future returns.

Focusing on income and capital value enhancement

RGL’s H224 £110m equity fund-raise has allowed for the repayment of debt (the FY24 LTV was 41.8% vs 58.3% at H1) and provides capital for investment in the portfolio; as part of its rolling refurbishment programme and to capture a greater share of the upside from disposals for alternative use. While RGL remains income-focused REIT, this strategy tilt suggests a more flexible approach to capital allocation as the company seeks to optimise the balance between income distribution and investing to enhance capital returns. RGL has now committed to 10 capital projects (a total investment of £16.5m) and disposals are continuing: £30.8m (before costs) during the year (£8.9m in H2), in line with prevailing valuations, with a pipeline of 43 potential further disposals, valued at £104m (c 17% of the portfolio).

Valuation: Yet to reflect recovery potential

As a normal pattern of quarterly DPS payments is re-established in FY25, our forecast DPS, 1.2x covered, represents a yield of c 10%, broadly double that of peers. The c 50% discount to NAV compares with c 30% for peers.

Further details from the trading update and forecast changes

Forecast update

FY24 trading appears to be in line with our existing forecasts and our only change is to reduce EPRA NTA, reflecting the further decline in valuations in H2 (we had previously assumed no change). Our revised FY24e EPRA NTA of 209.7p/share is reduced by 5.4%. This feeds through into FY25 and FY26, although we have assumed some external offset from lower interest rates and internal support from asset management.

For FY25 we now expect earnings and DPS to increase at a slower pace, primarily because we think it will take longer than previously assumed for the positive impact of refurbishment and re-letting to emerge. Although the number of committed capital projects is increasing, H224 capex of c £3.0m was less than in H124, and well below the c £20m pa that we expect in the next couple of years. These projects will take time to work through, with assets being held vacant for longer in order to maximise total return over time. FY25e EPRA earnings is reduced from £23.6m to £22.1m (FY24e: £21.3m). We expect some of the reduction to be recovered in FY26.

The progression of DPS continues to be obscured by the capital raise, DPS re-base and share consolidation (one for 10) undertaken in FY24. Reflecting the consolidation effects, RGL declared a 12p DPS in Q124, followed by three quarterly payments of 2.2p, or an aggregate 18.6p. FY24e EPRA earnings of £21.3m compare with total dividends declared of £16.9m, or 1.13x cover. For FY25e we now forecast growth in dividends to £18.5m or 11.4p per share (13.0p previously), with 1.20x cover. While REIT rules require 90% of rental income to be distributed, RGL does have flexibility to manage the balance between immediate income distribution and portfolio investment to maximise return potential over the medium term. Compared with EPRA earnings, the income that is distributable under REIT rules may be reduced in the near term by utilising capital expenditure allowances.

Based on our revised FY25e DPS expectation, RGL will continue to have one of the highest yields and strongest dividend cover ratios in the sector.

Premium to ERV

Although new leasing is yet to show a material uplift, the premium of achieved rents over estimated rental value (ERV) has continued to widen. RGL exchanged on 61 new leases (17 in H2), adding £3.2m pa (£1.1m in H2), compared with 88 lettings and £3.8m of annual rents in FY23, albeit on a smaller portfolio (126 properties at end-FY24 versus 144 at end-FY23). Importantly, the rental value uplift versus ERV of 13.5% for FY24 as a whole was ahead of H1 (8.4%) and FY23 (7.1%).

Strong increase in environmental credentials

The portfolio’s sustainability metrics have strengthened significantly over the past two years, in step with occupier demand for energy-efficient properties. At end-H124, the proportion of the portfolio rated EPC C or better (a 2027 minimum regulatory requirement), including those that are exempt from a rating, had increased to 82%, from 57% at the end of FY22. Properties rated B or better (a 2020 requirement), including exempt properties, reached 56%, up from 24% at end-FY22. RGL is very confident of meeting energy-efficiency requirements through its rolling capex programmes, aligned with leasing events and disposals. Meanwhile, it expects a relative scarcity of good-quality, energy-efficient properties to be a key driver of rental growth. RGL says that only around a third of commercial property space in core regional centres is EPC rated B or above. In October, the company announced a joint venture with a leading pan-European photovoltaic developer to install solar panels on a number of the most suitable properties within the portfolio.

Back to the office taking shape

With most employers adopting some sort of hybrid working arrangement, the pattern of post-pandemic office use has become much clearer and RGL expects this to be reflected in occupiers having increasing confidence to make long-term leasing decisions. In January, the company published its annual tenant survey, which it believes is the largest of its kind, based on responses from its large, diversified tenant base. The survey’s results are based on a 74.5% response rate (by rent), with over 28,000 employees having taken part, and demonstrate a continuing improvement in the return to the office trend, which is confirmed by other recent reports and studies. RGL found that as companies continue to encourage staff back to the office, occupation is now ahead of the pre-pandemic level. Current active office occupation, defined as average desk occupancy during business hours, had increased to 75.3% (from 71.4% in February 2024), compared with the estimated pre-pandemic level of c 70%. Employees were shown to be attending the office for an average of four days a week.

Improving prospects for rental income

The positive impact of new lettings has been offset by lease maturities and tenant break options. Disposals have also reduced rent roll, but the impact is compensated by lower property operating costs (especially for vacant properties) and reduced borrowing costs. End-FY24 gross rent roll was £60.7m compared with £67.8m at end-FY23 (and £63.5m at end-H124), with disposals accounting for c £2.6m of the decline. ERV showed a smaller decline, to £83.2m, versus £87.0m at end-FY23. The gap between gross rent roll and ERV represents a significant income growth potential, primarily related to void reduction (through letting or sale). End-FY24 EPRA occupancy was 77.5% versus 80.0% at end-FY23 (H124: 78.0%).

Just as the conditions for an acceleration in leasing activity appear positive, both by volume and compared with ERV, the drag from lease maturities and break options should diminish in FY25. At the start of 2024, income ‘at risk’ from maturities over the following 12 months was c £10m, or c £20m including break options. H124 data showed FY25 income at risk from maturities of £7m, or £12m including break options.

Continuing disposals

Total disposals in FY24 amounted to £30.8m before costs, in line with their respective sale valuation dates, and reflect a net initial yield of 8.3% (10.6% excluding vacant units). RGL has since completed three sales for an aggregate £1.6m before costs at 11% above valuation. The sales pipeline of 43 assets valued at c £104.3m comprises:

• Two disposals contracted for c £2.6m.
• Four disposals totalling c £12.3m under offer and in legal due diligence.
• Two further disposals totalling c £3.2m are in negotiation.
• 12 further disposals totalling c £21.3m are on the market.
• 23 potential disposals totalling c £64.9m are being prepared for the market.

Gearing has substantially reduced

End-FY24 gross borrowings were £317m and net (of cash) borrowing was £260m with a loan to value ratio (LTV) of 42.8%. Net debt reduced by c £118m during H2, reflecting the £105m (net of costs) capital raise and the proceeds from property disposals. Borrowing costs are all fixed or hedged to maturity (a weighted average 2.9 years) at an average 3.4% pa. The gearing reduction already achieved and continuing asset sales will significantly strengthen RGL’s position in debt refinancing. The first debt maturity is the Royal Bank of Scotland, Bank of Scotland and Barclays syndicated facility in August 2026, the cost of which is hedged at 3.4%. At end-H124, £116m had been drawn from the facility, but this will have reduced somewhat since.