LXi REIT — Swift and accretive capital deployment

In June 2021, LXi announced its intention to raise additional equity under its existing placing programme. Reflecting the strength of investor interest and scale of suitable acquisition opportunities identified by the company, the issue was upsized from c £75m to £100m and closed in early July, with c 75.2m new placing shares issued at 133p per share. An additional c 2.8m shares were issued in a PrimaryBid offering, aimed at retail investors and on similar terms. In aggregate, c 78.0m new shares were issued, c 12.5% of the number previously outstanding, raising gross proceeds of c £104m. Including the new c 100.4m shares issued in March 2021 (at 124.5p), LXi has now issued c 221.6m of the 400m shares authorised by shareholders to be issued between 16 March 2021 and 17 February 2022.

LXi has a strong track record of quickly deploying additional equity resources into predominantly off-market investments that have been identified in advance. The proceeds of the March equity raise were deployed swiftly within eight weeks and, leading up to the most recent placing, increased debt facilities had also been substantially deployed. The c £80m of acquisitions just announced substantially deploys the recently raised equity, continuing this pattern, and with additional pre-let forward funding and sale and leaseback transactions in solicitors’ hands we expect full deployment to be quickly achieved.

The acquisitions are all let on long leases to strong tenants that operate in defensive sectors. Starting rents are low and inflation-linked or subject to fixed uplifts, and in each case the assets benefit from being ‘mission critical’ for the tenant and/or having a favourable investment to vacant possession value ratio. Full details of the acquired assets are available on the company’s website (www.lxireit.com) and in summary they comprise:

Alongside the acquisitions, LXi reported the disposal of a Lidl food store, acquired through a forward funding transaction in 2017, following an unsolicited approach. The sale price of £7.75m reflected a low exit yield of 3.8%, a 38% premium to the acquisition price, which reflected a net initial yield of 5.5%. The sale proceeds will be recycled into higher-yielding opportunities within the continuing pipeline.

We have updated our estimates to include the £104m (gross) of equity recently raised and our expectations for its deployment, on a geared basis, including the acquisitions detailed in this note. A summary is provided in Exhibit 1. Our DPS forecasts are unchanged, although we note the increasing level of cover by ‘cash’ earnings in FY23 (1.08x), which raises the possibility that FY23 DPS growth may be faster than we assume.

Our previous forecasts assumed £185m of capital deployment after the March £125m gross capital raise. Following a string of transactions up to and including the £19.0m forward funding of a Dobbies garden centre announced on 10 June, c £15m of this assumed deployment remained ahead of the equity raise announced in June. We estimate that the net proceeds of this equity raising, geared (at an LTV of c 30%) utilising existing debt facilities, will support an additional c £145m of investment. Allowing for the £80m of deployment announced, our forecasts include future assumed deployment of £80m, £35m by end-September 2021 (end-H122) and the balance in H222. The £35m that we assume by end-H122 is equivalent to deployment of the £15m ‘brought forward’ and the full net equity proceeds of the July placing.

We also allow for capital recycling, assuming c 10% of the completed asset portfolio is sold each year (at book value and reflecting the existing portfolio yield) with the proceeds redeployed into new opportunities. We include the disposal of the Lidl food store in Chard within this.

For all future deployment, including recycled capital, we assume a c 50:50 split between completed assets and forward funding commitments at an average 5.5% yield on invested/committed capital (before acquisition costs). This implies an acquisition net initial yield of between 5.15% and 5.4% depending on whether the assets are completed properties (we assume standard acquisition costs of 6.8%) or forward-funded developments (we assume acquisition costs of 2%).

Based on the lease structure (95% of leases index-linked or fixed uplift at end-FY21) and inflation expectations (see section below), we assume a blended average uplift in rents of 2.6% pa through FY22 and FY23.

With its recent equity raise, LXi disclosed an unaudited EPRA NTA per share as at 1 June 2021 of 130p, up 3.4% since 31 March 2021 (end-FY21), substantially driven by portfolio revaluation gains, with an independent third-party portfolio valuation of £1.08bn reflecting a 4.7% net initial yield (end-FY21: 4.9%). Since end-FY21, each of the real estate subsectors within the portfolio had experienced like-for-like gains in valuation, with the largest contributor being the industrial and logistics assets, benefiting from continued strong investment markets, good covenants, and attractive supply and demand fundamentals. Recently purchased assets, those acquired since end-FY21, also showed increased valuations, on average 9% compared with the acquisition cost. Our capital value forecasts reflect the 1 June position and anticipate further valuation uplifts driven by rental growth and post-acquisition revaluation gains, which derive from LXi’s ability to source off-market properties and forward funding opportunities at attractive valuations.

Despite the pandemic, since listing LXi has achieved its aim of providing shareholders with secure and growing income, fully covered by adjusted earnings along with capital growth over the medium term. For FY22, LXi targets DPS of 6.0p, a new high since IPO. Including capital growth, EPRA NTA total return from IPO to end-FY21 was 48.0%, or an annual average increase of 10.1%, well ahead of the medium-term target of at least 8%.

LXi shares offer a 4.1% FY22 prospective yield and we expect further DPS growth in FY23, fully covered by ‘cash’ earnings. With capital growth underpinned by the strong start to FY22, our forecasts also imply an above-target EPRA NTA total return over the next two years (13.0% in FY22 and 8.4% in FY23).

Rising levels of inflation are an increasing cause of concern for investors, although forecasters are sharply divided about whether this will prove to be enduring or a transitory phenomenon, with inflation subsequently declining. LXi’s index-linked leases (mostly capped and collared) and fixed uplift leases provide significant income protection against inflation,1 while conversely, fixed rents and rent collars (minimum uplifts to indexed rents) ensure continuing rent growth if inflation falls to low levels.

Of the 95% of rents that were indexed or fixed at end-FY21, 74% were indexed to inflation (57% indexed to RPI and 17% indexed to the consumer price index (CPI)). The 21% of rents that provided fixed uplifts did so at an average of 2.4% pa. Taken together, the fixed and collared income amounts to 67% of the total at an average minimum uplift of c 2.0% pa regardless of how low inflation may fall. Rent reviews concluded in FY21 generated average uplifts of 2.1% pa.

As economies begin to recover from the pandemic, CPI inflation has risen markedly, to above the Bank of England (BoE) monetary policy committee’s target of 2% and is projected to rise temporarily to 4% in the near term. This is attributed to higher energy and goods prices, which in turn reflect rising commodity prices, transportation bottlenecks, constraints on production and strong global demand for goods. As such, the BoE expects above-target inflation to be transitory, as commodity prices stabilise, supply shortages ease and global demand rebalances.

The most recent UK inflation data for July 2021 showed some moderation compared with recent strong increases, with the 12-month change in the CPI falling to 2.1% compared with 2.5% in June, while the 12-month change in RPI was 3.8%, compared with 3.9% in June. The Treasury comparison of independent forecasters for June 2021 shows a mean expectation that CPI will be increasing at a 2.3% rate by Q421 and at a similar rate in Q422, but there is a high level of uncertainty reflected in a wide range of expectations, from 1.5% to 3.7% for 2021, and from 1.1% to 5.2% for FY22. A similar trend is apparent for RPI, with a mean expectation of 3.2% in Q421 and 2.9% in Q422.

Compared with its peer group of long-income peers (mostly comprising subsector specialist investors but also diversified investment peers such as Secure Income REIT and, to a lesser extent, LondonMetric), LXi has an above average WAULT and trades with a trailing P/NTA and yield that are both slightly lower than the average. For comparative purposes, the DPS and NTA/NAV data are shown on a trailing basis, taking the last 12 months DPS declared and last reported NTA/NAV. Prospectively, we forecast a good level of growth in LXi’s NTA per share and DPS over FY22 and FY23. LXi’s share price performance is well ahead of the peer group over the past 12 months and is also ahead of the UK market and broad property sector despite both benefiting from a recovery in the prices of stocks that were hard hit by the pandemic.