Custodian Property Income REIT plc (CREI) Earnings Call Transcript & Summary

Good morning, and welcome to the Custodian Property Income REIT plc investor presentation. [Operator Instructions]. I would now like to hand you over to Managing Director, Richard Shepherd-Cross. Good morning to you.

Thank you, and good morning, everyone. Nice to be speaking to you again following the release of our full year results -- full year to March 2026 results. For those of you that don't know Custodian Property Income REIT so well, just a brief explanation about what we're all about, starting with our aim, which is to be the REIT of choice for private and institutional investors, seeking high and stable dividends from well-diversified U.K. real estate. And I think that mission statement really sets out quite succinctly, but very clearly, what we're trying to do and how we might differ from any of our peer group funds. In a bit more detail, we provide access to a regionally diverse portfolio in an institutional grade package, main market listed and gross assets of GBP 690-odd million at 174 properties. So our average lot size, GBP 3.8 million which makes us a little bit different from many of our peers. And as we go through, perhaps I'll explain why we have chosen that path. One of the benefits of this broadly diversified portfolio of slightly smaller, but still good quality properties is that we have a higher income yield from the portfolio, which supports earnings, which in turn supports a fully covered dividend, dividend of 6p per share, which at year-end was a 7% dividend yield as at today, 6.85% share price has moved on a bit since then. And all invested in a portfolio that has significant reversionary potential. What do I mean by reversionary potential, the passing rents, the rents we're collecting today from the portfolio of GBP 49.2 million, yet the estimated rental value of the whole portfolio is GBP 55.6 million, so a 13% reversionary potential coming down the line. So looking at the results for this company, what we see is another positive year of operational performance and it is all coming from rental growth. Rental growth is what you should be looking for as a real estate investor. And if we look at some of the numbers that have led to the performance that we'll talk about, contractual rent has gone up 3.4%. Our value estimate of the rental value of the portfolio has gone up 3.3%. So that rental reversion that we are chasing is growing and we are still surfing that wave of rental growth. That has led to our 6p per share dividend being 105% covered by the recurring earnings of the company. And as I said, with that significant reversionary potential. And you can see in the table below that this year makes the third consecutive year of positive earnings growth. EPRA earnings per share up to 6.3p. Like-for-like estimated rental value, ERV growth, you can see over the last 5 years has been strongly positive, and it's that underlying rental growth that is the engine room of our earnings growth and then our ability to grow the dividend as we have over the last few years. Looking in a bit more detail, you can see here, the rental growth potential of each of the different sectors within the portfolio from industrial, which has seen the strongest rental growth and continues to have significant reversionary potential, 4.1% rental growth through the year. What is notable about this chart is that for the first time in a number of years, we are seeing positive rental growth from high street retail and from our office portfolio, which means that all sectors of the Custodian Property Income REIT portfolio are showing positive rental growth through the year. And as I said, that is what you should be looking for. And of course, what it tells us is that this is now a great time to invest, invest while rents are growing. But while you're still at a low point in the valuation cycle, the values fell following the increase in interest rates in 2022, and we have seen positive valuation growth since around about September 2024. So a full 18 months of positive rental growth, but the market is only just starting to pick up on that opportunity. Why is that? I think there's been an awful lot of geopolitical and indeed, domestic political noise through the years from 2024 until today. And all of that noise has been a huge distraction from the very strong sustained recovery we're starting to see coming out of the real estate investment market. And as a result of all of that noise, the opportunity to invest remains wide open. We haven't seen share prices race away on the back of that underlying growth that we're seeing in our portfolio and more generally across the market. And Custodian has always operated with a, I think, defensive balance sheet, as at today, gearing of 25.9%. And broadly speaking, 2/3 of the debt is fixed rate. So you can see GBP 45 million fixed until 2028 at 2.99% all-in and GBP 75 million fixed until 2032 at 3.5%. And the balance -- the other 1/3 is a revolving credit facility, that's variable rate debt, which is around about 5.5%, just a little over. That gives us a weighted average cost of debt of 4.1% and an average term of debt of 5 years. So very defensive balance sheet and that weighted average cost of debt of 4.1% needs to be held up against the portfolio that is yielding 6.5% which means that debt continues to be strongly accretive to earnings. When we consider the valuation growth we've seen through the year, net asset value total return of 10%, following 9.5% last year. So supporting my view that we've seen valuation growth since 2024. Breaking that down a little bit like-for-like, valuation growth across the portfolio, 2.7% and on a net asset value per share 3.7%. Now some of these numbers are starting to recur. Where has that 3.7% NAV growth come from? Will it come from a 3.4% increase in the rental roll. It's come from a 3.3% increase in the estimated rental value. And I think what you can see very clearly is that direct link between rental growth and valuation performance. And the good thing about the valuation performance we're seeing at the moment, it is not based on yield compression. Yield compression is a result of falling gilt rates and property yields chasing gilt rates down such as we saw in the sort of 2010 and teens. It is delivered -- it's being delivered through the underlying rental growth of the portfolio. And that means it's sustainable rental growth. And all of this has led to the strongest asset management performance we've seen since 2022. And looking at that in a bit more detail what has driven this asset management growth? Well, 53 lease renewals or lease regears, securing GBP 7.5 million worth of our rent roll. 9 rent reviews through the year and an average 6% rental increase. We sold nearly GBP 20 million worth of property, 23% ahead of valuation. And it's those property sales that have helped us fund a capital expenditure program which is so important for keeping the portfolio up to date and making sure that we are attracting the best tenants and securing the best possible rents. And part of that capital expenditure program has been to meet our partly self-imposed, but partly legislatively imposed, requirements to improve the environmental performance of the assets in the portfolio. So when we talk about a weighted EPC, the energy performance certificate of each and every property in the portfolio. That has, on average, on a weighted average basis come down from -- down being better than up, come down from a C rating and a score of 52 to a B rating and a score of 48. And this is in line with the requirements that will be imposed upon us through minimum energy efficiency standards, MEES regulations, and we are confident that the portfolio will be and will remain compliant. And what we are finding is that where we spend money on the properties and improve the environmental performance of the buildings. We attract better tenants, we get higher rents. We let the properties faster. So we see this as a real opportunity. And one of the benefits of being a real estate investment trust is that we have the -- we have the capacity, the financial capacity to spend the money where we need to spend the money to keep the portfolio assets relevant. And there, you can see the portfolio income yield numbers that I referenced a little earlier when we were discussing debt costs of 4.1%. Portfolio is yielding 6.4% today and with the potential as we pick up that rental growth to be well over 7% in the not-too-distant future. So comfortably ahead of the cost of debt. And this is one of the peculiarities of the custodian property income REIT strategy is that because we focus on a portfolio of regionally diverse assets that have a higher dividend, a higher initial yield, we are better able to operate in the higher income rate environment that we now see. So as well as growing the existing assets in the portfolio, we have had a very focused growth strategy through the year to March. And that is in corporate acquisition of private property companies in all share transactions. So rather than buying private property companies for cash, we have used shares in Custodian Property Income REIT as a proxy for cash in what you would refer to as a net asset value for net asset value share exchange. So we buy the share capital of the private family property company with the shares of custodian Property Income REIT. Now why would we do this? Well, let's start by looking at it from the private property company's perspective. And I'll paint a picture of a fairly typical private property company. It might be 1 generation old, it might be 2, it's rarely more than 3 generations old. It's just the nature of family businesses. They don't always make it down through multiple generations. Private family property company own regionally diverse assets, well suited to the Custodian portfolio. And they tend to be run by the senior generation in the family. And very often, they run them well into their 70s and into their 80s because the next generation don't want to take over the management of the family company. It might not be their interest. It might be that the next generation are too diverse, and therefore, it's difficult for any one person to take it on. And the assets haven't been passed down to the next generation because nobody wants to run them or because you can't split them equitably between the next generation. So what we propose to the family or private property company is that we will acquire their portfolio for shares in Custodian Property Income REIT. And in a stroke, that resolves the succession issue. We're now managing the portfolio so that management has passed on. And the shareholders in the private property company now have an equitably divisible asset, shares in Custodian Property Income REIT that they can pass on to the next generation. They also have a more diverse portfolio with more secure income that is personally managed by us. All of that sounds very attractive, but it's really attractive when you consider the tax benefits. As a real estate investment trust, we don't pay corporation tax on chargeable gains. And in a private property company that might have held assets for 10, 20, 30, 50 years sometimes, there is often a significant chargeable gain, and it has been one of the reasons that the assets haven't been sold in order to pass cash on to the next generation because they don't want to realize that gain and pay the tax on the gain. But because we are a real estate investment trust, and we don't pay tax on chargeable gains, we can pay gross price for the share capital of the private property company without an offset to reflect the potential tax charge because it doesn't apply to us. As an all-share transaction and a corporate transaction, there is no Stamp Duty land tax, there's a 5% charge that is avoided in this transaction. And it's possible for the private property company shareholders to get rollover relief on the personal CGT liability on the shares they hold in the private company when they transfer from private company to Custodian shares. That personal CGT liability isn't extinguished, but you don't have to settle it. You can get rollover relief. So it's a very tax-efficient transaction and the private property company then have shares in a much larger, more liquid company. So you can see why it would be appealing to a private property company. Why is it appealing to us? We think now is a great time to be buying real estate. And we can't raise new capital through share issuance because our shares are trading at a 10% to 12% discount to net asset value. We can't issue shares at a discount to net asset value. But by growing the portfolio through the issue of new shares on a net asset value for net asset value exchange, therefore, not at a discount, we can grow the portfolio, capture more of that rental reversion that we talked about at some moments ago. And the sort of transactions that we've done very quickly through these, we acquired Grove Court Properties, which is a GBP 36 million diversified portfolio with car showrooms and retail and some offices in Beaconsfield and Gerrards Cross, very high-value parts of the country. We acquired an GBP 8.5 million portfolio of car crash repair centers through -- spread through the Midlands and the Southeast, highly reversionary property, initial yield of around 7% with the potential to see a reversion of over 9% yield. So attractive and just the sort of assets that we like to own. And then the first of these transactions that we completed a little over a year ago, the Merlin portfolio, GBP 22 million diversified portfolio, a very good fit with us mostly in the East Midlands and yielding over 8%. So you can see very attractive portfolios that support our overall strategy. So where does that leave the portfolio today, still broadly diversified, focused on the areas in the market where we see the most rental growth, remembering that we are seeing positive rental growth in all sectors at the moment. But the strongest rental growth was in the industrial and logistics sector, which is where 42% of our income is derived and retail warehousing, another 22%. We still have some prime high street assets. We've broadly sold out of small market town retail and city center offices, which we favor over out-of-town business parks, which tend to be -- which tend to have struggled much more than prime city center locations. So that's the balance of the portfolio and spread, as you can see in this map, very broadly across the country. Of course, all of this spread is diversifying risk in any 1 building in any 1 location. And for those key geographies who know the U.K. well, you will see that we are broadly concentrated in the commercial heartlands of the U.K. And then the chart that I think really says it all is this pie chart, which looks at the amount of income that is derived from any single tenant in the portfolio. And there are very few real estate investment trust that could put up a chart that looked quite as diverse as this. Even amongst our largest tenants, there is further diversification. So InPost, 3.45% of the rent roll, but we have 8 properties let to InPost. Wickes, just under 3% of the rent roll and 5 properties let to Wickes. So further diversification amongst that. And I think one of the challenges that sometimes -- that we sometimes face is people say, well, shortly you've got all these small properties, you've got lower quality tenants. Well, I think -- I hope you've seen as we've been turning the pages on these slides. The photographs of the properties that are very typical of the assets that we own, good quality properties often let to household names. And if you look at the quality of our tenant by reference to an Experian credit rating, you can see that 82% of our tenants are considered lower-than-average risk. So in summary, good quality tenants, very broadly diversified income, modern or fit-for-purpose assets spread across the U.K. with rental growth potential, supporting a fully covered dividend of 6p per share and a dividend yield as of this morning of 6.8%. And and at a low point in the valuation cycle now feels like a very good time to invest. And there are a number of people who've seen this opportunity and what this chart is showing is really the top slice of our shareholder register and where there has been significant change and the significant changes come from 2 specific areas. One from that dark blue line, the private property companies we've acquired, adding significant and long, hopefully, long-standing shareholders to the register. They have been invested in real estate for many years, and they've switched from their private property companies into Custodian, which is a public property company with greater liquidity. So it's been a significant increase. And then the other large group have been retail investors investing through the typical investor platforms that we all know, AJ Bell, Hargreaves Interactive investor, 33.4 million new shares in the hands of retail investors through the platforms in the last 3 years. And I think they have been attracted by the income and the security and that diversification that we've talked about. So there's some important information for you to read. I won't force you to do that, but I think these shares are going to be -- these slides are going to be shared.

And I think we'll now move on to the Q&A. And thank you for anyone who has submitted a question. I've got them on the screen here, and I will take them in the order that they have been submitted. So the first is any size of a modest dividend increase. Well, we talked at the start I put up a slide that showed the earnings growth that has been supported by rental growth and the dividend growth that we've seen on the back of that. Dividend last year was 6p per share. We've announced that it will be a minimum 6p per share for the year ahead, and that dividend is 105% covered by earnings. I think what I -- all I can point to, because clearly nothing has been announced is -- it has been the strategy of the Board to increase dividends on a sustainable basis where the finance is allowed. We're in a period of rental growth. We have also been in a period of increasing interest rates. And while we have fixed rate debt at the moment, that won't run forever. There will be a requirement to refinance that in due course. So we have to look forward and balance the rental growth that we're seeing coming through, the potential for an increased cost in debt service against the ability to pay a higher dividend. But I think what history tells us or the custodian property income REIT's history is where there has been capacity to increase dividends then that has been the strategy of the Board. So the next question, which sector of the property portfolio is most challenging to achieve the 2030 EPC requirements and why. We talked about EPCs a little bit. And I think we have a good track record of spending the money where it's needed to make sure we meet the 2030 minimum energy efficiency standards that have been set by the government, which is -- which was a B EPC for every property. It's something we are planning for. It's not something that we are concerned about. The most challenging assets, it's not really a sector-by-sector challenge. It's probably an age of building challenge if you -- I mean, let's break it down. Shops on the high street pretty straightforward. It's normally just about lighting because they tend to be in terraces and therefore, reasonably well insulated. Industrial buildings actually pretty straightforward. You can overclad roofs and add to insulation on the roofs. More often than not, when we are refurbishing our industrial buildings. We close off any gas supplies and to electrify the buildings, and that is a key driver of energy efficiency because if we have electric heating and cooling. We introduced solar panels, which we've done successfully across the portfolio -- and we use green sources of electricity, then it's quite easy to meet the requirements. And the same is true of retail warehouses, which are fundamentally sheds as well. So it's not something we're concerned about. It's something we're focused on. And as and when the properties come back to us, we make sure we improve those EPCs and solar PV rollout across the roofs of our portfolio. It will be a big part of that. So the next question, in terms of refinancing the fixed rate debt, when you approach the lenders for new terms, existing or extending the term, do you think we are into a higher for longer macro scenario for both long-term gilt yields and inflation? What will be the interplay between the 2 for returns for property investors, i.e. higher cost of debt versus higher rental growth and inflation? I think that we probably should expect inflation to run hot for some time to come. I think that the Bank of England have got a fine balancing act with interest rates, and it's interesting to see they didn't increase rates last week. And perhaps that was in line with my expectations, and little do I know, but -- it would feel like kicking a man when he was down to put up interest rates, which would only be inflationary in these situations because the driver of inflation is not in the current world, excessive demand, it is simply -- it has simply been the oil price. But I think we should expect interest rates to not fall significantly from where they are. And I don't think we should be concerned about that. Real estate was a very sensible investment asset class when interest rates were 5% and above. And we had an extraordinary period when interest rates were close to 0, but I don't think we should expect or even wish to get back to those sorts of -- those sorts of rates because it would suggest real weakness in the economy of interest rates had to come in that much. So real estate works with interest rates where they are, when it comes to extending our existing debt terms, are we going to be able to fix again at 2.99%. No, I don't think we will. So we need to allow for that in our forecast. But we do have rental growth, which will help offset a significant proportion of that impact. But it remains a balance. But I would have thought inflation is going to run hot for a little while longer. I don't think interest rates we should expect to come down significantly, neither perhaps should we wish for them to -- and I think real estate will cope just fine. So the next question, again about debt with the GBP 75 million revolving credit facility, 87% drawn at close to 5.7%, all-in constraining acquisitions and the shares below net asset value ruling equity issuance, what is the funding path to a dividend above 6p or what level of EPRA earnings does the Board require to progress it and when? So I think a lot of these questions are pointing the same issues, and I don't want to repeat myself. I think there is a path to increasing the dividend, and it is going to come from rental growth. I think there is also a path to growth through the corporate acquisitions that we talked about. And I think we -- as shareholders, you should expect to see more of that in the future. We think it is a significant opportunity both for our shareholders and for private property company shareholders to come together and consolidate. And for us then to capture more rental growth from the assets that we're acquiring. So there isn't a hard and fast level of EPRA earnings per share that requires -- that is required to see dividend growth because it's a balance between that debt expectations, et cetera. Another question, if you're trading at a discount, are you able to buy back your own shares to use to acquire the family business that you've referred to when buying the shares rather than cash. We can use -- we can use money to buy back our own shares, and we've done a little bit of that. About 5 million shares have been bought back at an average 78p per share. So that's been accretive to earnings and that's a positive for existing shareholders. When we are buying private property companies in net asset value for net asset value share exchanges, we actually issue new shares. We don't need to buy them back. We can issue new shares because we're not issuing at a discount. So the next question. You've highlighted further opportunities to acquire privately owned property portfolios. How active is your current pipeline and what characteristics make an acquisition attractive to Custodian? We have a very active pipeline. Some of it is more speculative than others. So watch this space. What makes it an attractive portfolio to us, it has to be property first. If the property assets fit, that's the starting point. If the property assets don't fit, we'll go no further. So this is a property-first strategy. We think there are tens of dozens of opportunities we are in various conversations. At the moment, as you would expect, and I don't think I'm giving away any secrets in saying that, but yes, property-first is the answer. Another question, your refurbishment program is delivering stronger rental values while improving environmental performance, how attractive are the returns you're currently generating from these investments? Well, I mean, very attractive. Just to put the second half of that question to one side, it is imperative that we continue to invest in the portfolio to make sure that our portfolio is match fit for what the modern tenants are demanding in all sectors, whether it's retail warehousing, whether it's industrial and logistics or whether it's offices. So it is a really important part of what we do, and we have a number of ways that we can fund that refurbishment program either through profitable sales or through cash flow or through gearing. And most recently, we've been using profitable sales to fund that. Typically, we are seeing probably somewhere to a -- I don't know. I don't know exactly. But I know, it's north of 7%. And often, it is strongly into double-digit return on investment in that refurbishment program. So if we're investing GBP 1 million in that building, we would expect to see a minimum 7% return on that and it often runs into double digits, where we have been adding solar PV to our buildings. After a year of generating electricity and generating additional cash flow because we sell that electricity to our tenants at a discounted rate. So they are beneficiaries, too. Then we move from holding those solar panels at cost to holding them at valuation and our independent valuers -- value those solar panels separately. What we have seen is that when we move from cost to valuation, we see a near doubling in value -- in value versus cost. So significant increase in value in doing that. So the question about where the shares come from to buy family or private companies, we issue new shares is the answer. So that's where the shares come from. We don't have a stash of them down the back of the sofa, we simply issue new shares, which we're able to do because we're not issuing them at a discount. Is there much room for more consolidation in the REIT market? Well, there are a number of companies, maybe a couple of companies that are under active consideration, for consolidation at the moment. News doesn't seem to be particularly positive around those consolidation stories. So probably not a great deal more room for consolidation. But then it was only last week that Prologis made an offer for SEGRO, who are the largest real estate investment trust in the U.K. So who knows? Who knows? But we all watch with interest. That is the end of the questions. So thank you very much for your time. I hope that's been a helpful update on Custodian for those of you who have followed us for some time and an interesting introduction for those that haven't. And we'll just conclude by saying, I think now is a great time to be buying into real estate. Valuations are in the recovery phase. They've been driven by rental growth, owning real assets in an inflationary environment makes good sense and property is demonstrating that in an inflationary environment, it is responding with rental growth. So it's protecting the real value of the pound invested. So thank you very much.

Fantastic, Richard. Thank you very much indeed for updating investors today. Could you please ask investors not to close the session as you will now be automatically directed to provide your feedback, which will help the company better understand your views and expectations. On behalf of the management team, we would like to thank you for attending today's presentation, and good morning to you all.