A turning point emerging

With its balance sheet transformed by the July 2024 (£105m net of costs) capital raise, RGL has considerable flexibility to enhance portfolio income potential and maximise disposal values. Occupiers continue to accept higher rents for good-quality office space and RGL expects this to be maintained by a growing supply-demand imbalance. RGL lettings in FY24 were at an average 13.5% premium to estimated rental value (ERV). The company expects 80% of the portfolio to meet occupier requirements and generate long-term income and capital growth. The remaining 20% will be sold, either in the near term or over the next three years, with valuations and total returns enhanced by being positioned for change of use.

Results and forecasts

In another challenging year for the sector, RGL’s FY24 results were in line with previous guidance. Lower net interest cost and administrative expenses only partially offset lower net rental income. EPRA earnings of £22.7m compared with £27.0m in FY23, covering dividend distributions of £16.9m (FY23: £27.1m) by 1.3x. On a per-share basis, EPS, DPS and net tangible assets (NTA) were all materially affected by the heavily discounted capital raise and 10-for-one share consolidation. RGL expects FY25 EPRA earnings to be broadly flat, requiring only a modest change to our forecast, although we have reduced expected DPS and increased cover. RGL’s portfolio value was 8.2% lower in FY24 (MSCI office index: -8.9%) but the decline slowed in H2. We forecast a stabilisation and modest NTA/share growth, but have allowed for none of the potential from value-add change of use initiatives.

Valuation: Strong upside potential

With dividend distributions based on property income distribution rather than EPRA earnings (which are higher), DPS is at a sustainable level and allows for internal capital generation to fund capex. The FY25e yield is nonetheless c 9% and the shares are trading at a P/NAV of c 0.55x, well below peers on both measures. The upside from a successful execution of the strategy is material.

Strategy for value creation and sector outlook improving

With its balance sheet transformed by the July 2024 capital raise, RGL has a clear strategy to unlock value from its portfolio. Meanwhile, there are signs of the office sector headwinds receding. This is not yet reflected in RGL’s share price. In this note, we highlight the following:

• There is now much greater visibility on the post-pandemic use of office space. While most employers have adopted some form of hybrid working, RGL’s own survey shows employees are attending the office for an average of four days a week. An increasing number of employers are demanding or encouraging full attendance.
• The flight to quality continues, with occupiers willing to pay higher rents for good-quality, energy-efficient space. 58% of RGL’s portfolio is now rated EPC B or better and 83% C or better.
• FY24 lettings were at an average 13.5% premium to ERV and RGL expects a growing supply-demand imbalance to drive rents higher, especially for secondary Grade A space.
• The core of RGL’s portfolio is good quality and well let. Resources are now available for targeted investment to increase occupancy, income and valuation.
• RGL now has the financial flexibility to pursue value-add change of use projects, accretive to total returns, ahead of disposal. In other cases, non-core underperforming assets will be sold outright. Disposals will fund capex and further debt reduction.
• With an ERV that is £17m or 27% above the current roll, there is huge potential to lift income and grow fully covered DPS while supporting capital values.
• After several challenging years for the sector, RGL notes that a number of the large real estate agents are taking a significantly more favourable view of office sector prospects. While macroeconomic uncertainty remains heightened, there is no obvious reason why the office sector should be affected more than the wider market. The most recent Investment Property Forum UK Consensus Forecasts, published in March using data collected between early January and mid-February, are directionally in line with this trend. While the 6.6% pa consensus total return over the next five years continues to trail the wider market, the margin has narrowed considerably, while RGL has considerable company-specific opportunities.

Office attendance continues to increase

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, it 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), covering more than 100 office buildings, geographically spread, involving over 28,000 employees. It demonstrates 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. Active office occupation, defined as average desk occupancy during business hours, increased to 75.3% as of February 2025 (February 2024: 71.4%) 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.

The 2024 KPMG CEO Outlook provides an indication that office attendance will continue to normalise, with 64% of CEOs anticipating a full return to the office over a three-year period. Providing encouragement to this trend, 87% of CEOs said they were more inclined to reward those who attend the office regularly, in the form of salary increases, promotions or better projects.

Strong increase in environmental credentials to drive rent growth

The portfolio’s sustainability metrics have strengthened significantly over the past two years, in step with occupier demand for energy-efficient properties. At end FY24, 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 83%, up from 74% at end FY23 and 57% at end FY22. Properties rated B or better, including exempt properties, have reached 58% of the total, which RGL believes is more than twice the regional office market average of c 25%. It has for some time been expected that properties will need to have an EPC rating of B or better by 2030 and, although this is not as yet a legal requirement, it is increasingly demanded by occupiers and landlords must respond to attract tenants. RGL indicates that 50% of all office lettings in the regions in 2023 was for EPC A- and B-rated properties and that this will have increased considerably in 2024. With the market stock of EPC A- and B-rated space increasing by only c 8% pa (source: RGL), through refurbishment and new development, it is unlikely to meet the expected growth in occupier demand and RGL expects this demand-supply imbalance to drive rents higher. The 13.5% new letting premium to ERV that RGL achieved in 2024 is a strong indication of its ability to provide the quality of space demanded by occupiers.

RGL says that new prime space coming to market now, in projects started a few years ago, is commanding rents of £40–45/sq ft, below the £50–55/sq ft required by landlords to make new projects viable, and well ahead of the c £20–30/sq ft at which more secondary Grade A (EPC A and B) space is available. With little in the way of new development starts likely until rents increase, and completions even further off, the company expects this gap to close with a positive impact on its portfolio, about 60% of which is Grade A (and increasing with refurbishment), with average rents of c £15/sq ft.

Portfolio segmentation highlights pathway to value realisation

To illuminate the pathway to value creation, RGL has segmented the portfolio into four categories, two of which represent properties that will be held long term for income and capital growth (80% of the total) and two that represent future disposals.

Of those to be held long term, core properties are already high quality and mostly occupied, whereas ‘capex to core’ properties are well-located assets that are subject to ongoing refurbishment to realise their full potential.

Among the properties to be sold, ‘value-add’ assets have been identified as offering significant opportunities to add value by being positioned for alternative use. Where there is no such opportunity, assets (including remaining non-office) will be sold to redeploy capital.

In its full-year presentation, RGL provides several examples of recent capex to core projects, demonstrating improvements to asset quality, enhanced EPC ratings, increased occupancy and rents, with increased rental income in turn driving valuation gains. The return on capex can be very significant and, on average, RGL is targeting a 1.5–4.0x capital value return on the equity deployed.

RGL has identified 20 potential value-add opportunities where it is studying the feasibility of enhancing value through undertaking planning initiatives to allow alternative use (residential, student accommodation and some industrial) ahead of sale to developers. Depending on the nature of that use, these initiatives will be taken to different stages with the aim of optimising the likely risk-reward. In some cases RGL may simply seek to establish building density (what may be acceptable in the available space), stopping at the pre-planning application stage. In other cases it may seek planning permission in principle or full, detailed planning consent. Ultimately, these assets will be sold and the aim is to maximise the disposal value at the minimum cost. Helpfully, the planning regime has become more favourable to developers under the new Labour government as it seeks to simulate growth and ease the housing shortage.

Disposals in 2024 were less than RGL had initially hoped, reflecting a continued stand-off between sellers and buyers and a desire to maximise exit values. Total disposals in the year amounted to £30.8m before costs, in line with their respective sale valuation dates, and reflected a net initial yield of 8.3% (10.6% excluding vacant units), with sales continuing since. In total, RGL has identified 43 assets for potential disposal, with a value of c £107m at end FY24, although the sales market, outside of smaller lot sizes, is yet to pick up. The £107m includes non-core assets where investment would not meet the required returns, as well as potential capital recycling opportunities from across the portfolio.

Delivering net rental income and valuation growth

While the leasing market remained soft in 2024, RGL identifies the strong return to the office and a growing supply-demand imbalance for quality space as key positive indicators for medium-term income growth from core and capex to core assets, through higher rents, increased occupancy and reduced void costs. It estimates that in many cases, the impact on net rent from letting vacant space is twice the uplift in rent roll after eliminating void costs. Assuming no change in the valuation yield, higher gross rental income should also have a positive impact on valuation. The sale of non-core vacant assets is also positive for net rental income by reducing void costs with no impact on gross rents.

For a number of value-add assets, RGL will need to go through a period of vacant possession (lower income and higher void costs) as planning permission is pursued before sale. RGL expects these projects to be significantly value-accretive but this is only likely to be reflected in capital growth as permissions are secured and sales advanced. For the 20 projects already identified, RGL expects all to be substantially completed within three years, with some as early as 2026. Retained earnings and ongoing disposal proceeds will provide additional resources to fund capex while continuing to reduce borrowing.

From the £105m net capital raise proceeds, £28m was earmarked for accelerated capex of which c £22m relates mainly to refurbishment projects within the capex to core assets, with around £6m relating to potential fees and other costs for the value-add assets. FY24 capex was c £8m but will increase materially in FY25 and FY26 (we estimate c £18m pa). 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.

Reducing gearing ahead of refinancing

End-FY24 gross borrowings were £317m, down by £104m during the year, including repayment of the £50m unsecured bond in August and a £54m reduction in senior secured debt.

Adjusting for cash of £57m, end-FY24 net borrowing was £260m with a loan to value ratio (LTV) of 41.8%. Net debt reduced by c £118m during H2, primarily reflecting the £105m (net of costs) capital raise completed in July 2024. Borrowing costs are all fixed or hedged to maturity (a weighted average 2.9 years at year-end) at an average 3.4% pa. At the level of each borrowing facility, LTVs have reduced towards c 50%, enabling RGL to agree covenant adjustments, allowing for the part-release of sales proceeds to fund capex. 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, amounting to £99.8m at end FY24, with a 3.37% pa fixed cost comprising a lending margin of 2.40% with the floating SONIA benchmark hedged at a fixed 0.97%. Refinancing discussions are underway with the current and alternative lenders, which the company hopes to conclude before the end of 2025. It is seeking to lengthen the debt maturity profile towards five years but, depending on market financing conditions at the time, may initially opt for the flexibility of a shorter-term extension of the existing facility to benefit from potential future interest rate reductions. Our forecasts allow for the refinancing of the syndicated facility at c 6.4% pa, will a full-year impact in FY26. We also allow for refinancing of the £132.6m 3.28% fixed-rate Scottish Widows/Aviva facility ahead of its maturity in December 2027, at a similar c 6.4%, with a full-year impact in FY27.

Forecast update

FY24 earnings of £22.7m was above our forecast of £21.3m due to lower administrative expenses than we had expected. However, EPRA EPS of 19.2p was lower than our forecast 21.1p due to a higher average number of shares than we had allowed for. This will unwind in FY25. EPRA NTA and gearing were in line with our expectations. Further details of the FY24 financial performance are provided below.

For FY25e, there is a slight uplift to EPRA earnings, at a similar level to FY24, driven by lower administrative expenses, although EPRA EPS is lower because of a higher average number of shares, reflecting a full year impact from the capital raise. This is in line with RGL’s expectations of broadly flat earnings and dividends. Our FY25 DPS forecast is correspondingly reduced by 0.9p, comprising three quarterly payments 2.5p each, with a 3.0p Q4 top-up. Our FY25 forecast EPRA earnings of £22.5m is broadly in line with FY24 (£22.7m), with lower net interest expense (on reduced average debt) offsetting a reduction in net rental income and an increase in administrative expenses driven by the impact of a higher average NAV on investment management fees. Annualised rent roll at end FY24 of £60.7m was below the FY24 average of c £64m and this will be reflected in FY25 rental income. The reduction in FY24 rent roll included the impact of disposals (c £2.6m), intentionally holding vacant space and running down leases on the value-add properties, as well as the soft letting market.

In FY26e and FY27e, net rental income increases, more than offsetting an increase in borrowing costs as near-to-maturity existing borrowings are refinanced at prevailing higher interest rates. We expect gross rental income to benefit from a pick-up in leasing, partly offset by disposals. Property costs should reduce with increased occupancy, as vacant property is let or disposed of.

Our EPRA NTA includes only a modest contribution from portfolio valuation growth, driven by underlying rent growth with yields stabilising. We have not included any upside from the value-add investment given the difficulty in assessing this, and despite significant potential.

Valuation discount

RGL’s shares have a prospective yield of almost 9%, based a well-covered FY25e DPS of 10.5p. The discount to end-FY24 NAV is amost 50%. On both measures, RGL continues to trade at a discount to our selected peer group, comprising a mix of REITs with varying degrees of exposure to the office sector, regional properties and development/refurbishment. A successful execution of RGL’s strategy as set out above suggests significant upside potential.

FY24 financial performance

The FY24 results were in line with the previously published trading updates provided by the company and our forecasts. In particular, we highlight:

• Rental and other property income declined by £5m or 7% to £65m, reflecting lower occupancy and property disposals. H2 was slightly above the level of H1 and often benefits seasonally from dilapidation receipts.
• Non-recoverable property costs increased £3m to £19m, also reflecting lower occupancy as well as upward pressure including stricter rules on business rate relief on empty properties.
• Net property income was £8m or 14% lower at £46m, but the decline was partially offset by lower administrative expenses and net finance expense.
• Asset and investment management fees (directly linked to NAV) declined, while other administrative expenses were well controlled.
• Net finance costs benefited from interest earned on cash balances and lower average borrowing.
• EPRA earnings were £22.7m versus £27.0m in FY23. Dividends declared were £16.9m. Dividends were covered 1.3x by EPRA earnings, although RGL is now targeting REIT regime-compliant property income distributions, currently lower. Adjusted for the impact of the capital increase and 10-to-one share consolidation, EPRA EPS was 19.2p versus 33.1p in FY23.
• During FY24, RGL declared a Q1 DPS of 1.2p (before the capital raise and share consolidation), followed by three equal quarterly DPS of 2.2p (post the share consolidation and payable on the increased number of shares). Total dividends declared for FY24 of £16.9m compare with total dividends declared in FY23 of £27.1m. We present the per-share data in this way to ease comparison but note that the Q124 DPS of 1.2p was payable on the number of shares pre-consolidation, equivalent to 12.0p on the post-consolidation number of shares. On the same post-share consolidation basis, DPS of 18.6p (12.0p plus three payments of 2.2p) could be compared with 53p, providing a measure of the dilution incurred by shareholders who chose not to or were unable to exercise their entitlement to new shares in the capital raise.

• The IFRS loss of £40m included £60m of unrealised valuation losses. Including the £105m net proceeds of the capital raise, EPRA net tangible assets increased by £50m to £341m or 210p per share compared with 357p per share in FY23, re-stated for the capital raise and share consolidation.

Management structure and costs

Following completion of the capital raise, RGL’s board underwent important changes. In January 2025, David Hunter joined the board and became chairman in March following a period of handover. He succeeded Kevin McGrath, who had earlier announced his decision to retire at the completion of his nine-year tenure. David Hunter is a highly experienced non-executive director and chair of listed REITs, as well as a strategic adviser to real estate private equity businesses. He has a background in property fund management, latterly as managing director of Aberdeen Asset Management's £6.5bn real estate business, but since 2005 he has taken a wide range of non-executive positions in UK and international businesses. He has previously been chairman of Capital & Regional, Dar Global, Custodian Property Income and GCP Student Living, among other roles.

In October 2024, also at the end of his nine-year tenure, Daniel Taylor stepped down as a non-executive director. Also in October, Nicole Burstow joined the board as a representative of Bridgemere Investments, which became RGL’s largest shareholder during the capital raise, with an interest of 20.4%. She has over 20 years’ experience in the financial services sectors and is CFO of the Bridgemere Group of companies. Bridgemere is a ‘family office’ investor, established by Steve Morgan CBE in 1996, with strategic, long-term investments covering a range of sectors that include housebuilding, land and property development and leisure. He founded the housebuilder Redrow in the 1970s and Bridgemere was a cornerstone investor in two Tosca-managed funds that were reorganised as part of the creation of RGL in 2015. With his deep knowledge of regional property markets and significant experience of navigating the planning approvals system, particularly with respect to residential development, he is well-placed to contribute positively to RGL and especially its repurposing plans. In most cases, the alternative uses are ‘beds and sheds’, that is either for industrial use or some kind of residential use, including student accommodation, hotels and buy-to-let.

The other board members are Frances Daley, a chartered accountant with considerable experience in corporate finance and senior finance roles; Massy Larizadeh, with over 30 years’ experience across the financial services and commercial real estate sectors and a particular interest in environmental, social and governance issues; and Stephen Inglis (representing ESR Europe LSPIM, the external asset manager).

ESR Europe is the European platform of ESR Group, a global real estate investment manager with a leading
position in Asia-Pacific. It operates across the UK and Western Europe, bringing over 30 years of real estate investment and asset management experience delivered by a highly experienced in-house team, covering REITs and private funds in real estate, infrastructure and credit. In 2023, ESR acquired a majority shareholding in London & Scottish Property Investment Management (LSPIM, asset manager to RGL since it listed in 2017) from its founder and CEO, Stephen Inglis. ESR LSPIM has brought together the fully integrated asset management platform of LSPIM, supported by a dedicated team of almost 80 employees across a number of regional offices, with the significant resources of one of the world’s largest real estate managers.

With its strong board, the support of its significant new shareholder and the resources of ESR LSPIM, the company is well-placed to exploit the opportunities open to it.

Management fees are set at 1.1% of net assets up to £500m and 0.9% above £500m, split equally between ESR LSPIM as asset manager, and ESR Europe Private Markets, as the investment adviser. In addition, a property management fee of 4% of annual gross rental income is payable to ESR LSPIM.

The headline EPRA cost ratio including direct vacancy costs is high (c 45% in FY24) due to the low level of occupancy. Excluding direct vacancy costs, the ratio (17.4% in FY24) is broadly in line with, and even below, that of peers of a similar size. As RGL works through its letting and disposal strategy, increasing income and reducing void costs, the two EPRA cost measures should begin to converge. However, we expect disposals, including through value-add projects, to more than offset the positive impact of void reduction on rental income and partly tilt earnings more towards capital appreciation. Other things being equal, this will put some upwards pressure on the EPRA cost ratio, which excludes earnings from capital gains.

The benefits of RGL’s integrated asset management platform and its regional footprint were clear during the pandemic, evidenced by a strong rent collection performance, and should also support its current intensive asset management strategy. The resources that the current external management structure provides would be extremely difficult to replicate in a switch to internal management, as a number of REITs have done recently.

Portfolio details

At the end of FY24, RGL’s portfolio comprised 126 assets with a value of £623m. Offices in key regional centres outside the M25 motorway are RGL’s ongoing focus, representing 107 assets and 90.7% of the valuation. The balance of the portfolio by valuation is made up of retail (3.6%), industrial (3.7%) and other (two leisure assets, 2.0%). The non-office assets are not core to the portfolio and will eventually be disposed of, but currently provide a good level of income with above average occupancy. The portfolio net initial yield of 5.9% versus a reversionary yield of 11.6% reflects the current level of occupancy (77.5% on an EPRA basis at year-end).

While focusing on the office sector, income risk is mitigated by diversification across a wide number of properties, tenants and geographies. Tenants operate across a wide spread of business activities, with different economic and market drivers, and varying levels of sensitivity to the broad economy. The largest property represents 2.9% of rent roll and the largest tenant 1.7%, spread across two different locations.