A smart play on the office property market recovery

Circle Property (CRC:195p), an internally managed Jersey-registered property company that actively manages a £132m portfolio of well-located regional office properties, has outperformed the benchmark MSCI All Property Index for the fifth consecutive year. True, like-for-like valuations still declined by 1.8 per cent due to yield shifts and led to a 3.8 per cent fall in net asset value (NAV) per share to 274p, but this was far better than peers and the MSCI index (6.1 per cent decline).

High occupancy rates of 96.4 per cent across a portfolio of 13 highly reversionary regional properties, of which 88 per cent are located in Milton Keynes, Maidenhead, Birmingham and Bristol, combined with robust rent collection rates (91.5 per cent), drove up annual rental income 2 per cent to £7.7m and helped full-year adjusted pre-tax profits (pre-portfolio fair value movements) increase by a third to £3.4m.

The latest property valuation reflects a running yield of 6.6 per cent based on contracted annualised rental income of £8.7m. However, with estimated rental values (ERV) £2.2m higher, implying 8.3 per cent reversionary yield, then Circle is able to let vacant properties at competitive rents to drive up its contracted rent roll, the effect of which is to support valuation gains as letting market activity returns to more normal conditions. There are signs that could be already happening.

The company’s astute management team led by chief executive John Arnold has proved adept at adapting vacant space to meet the changing needs of tenants during the Covid-19 pandemic. For instance, high-spec modern fit-outs at Concorde Park, Maidenhead and 36 Great Charles Street, Birmingham has provided 16,000 sq ft of office space for immediate occupation. Arnold notes that “deals have been agreed [but are yet to convert] and there has been a noticeable increase in viewings”, adding it looks like the “beginning of a renaissance.” In addition, a 13,800 sq ft office property in Bristol (vacated by the previous tenant in January) has already been let out on a 15-year lease at £0.3m per year following a £1.5m refurbishment.

Following the £3.55m disposal of a Milton Keynes property at 9 per cent premium to book value just before the March financial year-end, Circle’s portfolio had a net loan-to-value ratio of 44 per cent at the 31 March 2021 year-end. Further sales are planned in the current financial year to reduce gearing to a range (30 to 40 per cent) and help fund the £2m refurbishment of a 15,000 sq ft building on Circle’s largest business park in Milton Keynes, Kent Hills, a 244,000 sq ft complex encompassing offices, hotel, health centre and conference facilities. There is potential for a major liquidity event, too.

That’s because FTSE 100 food and support services group Compass (CPG) occupies the majority of Kent Hills and pays £1.6m of rental income on a lease subject to annual RPI-linked uplifts, which has 20 years unexpired. The property has been valued at around £35m, accounting for almost 25 per cent of Circle’s £132m property portfolio. It should prove attractive to institutions looking for a blue-chip covenant as well a hedge against inflation risk. Arnold says that the property “is out in the market and we’re talking to number of parties.” A sale this year looks increasingly likely, a sentiment shared by Arnold who believes “it’s day is coming”.

Deleveraging the balance sheet should help drive a narrowing of the unwarranted 29 per cent share price discount to NAV. In comparison, UK commercial property sector average discount to NAV is 5.8 per cent based on Liberum Capital’s universe of 19 companies. Reducing debt should also enable the board to increase the pay-out ratio, too, having just declared a 23 per cent higher full-year pay-out of 6.5p from adjusted earnings per share (EPS) of 9.9p. Cenkos is forecasting current year EPS of 10.9p, annual dividend per share of 7p and NAV of 288p at 31 March 2022.

Admittedly, Circle’s shares have declined 6 per cent since I suggested buying at 208p (‘A deep value property play’, 21 February 2020), albeit 4.5p a share of dividends paid since then and the proposed final dividend of 4p a share (ex-dividend of 15 July 2021) offsets most of the paper loss. More importantly, as the UK economy rebounds, and institutional property investors look to take advantage of the favourable yield premium regional office property offers in a zero-interest rate policy environment, I expect capital values to produce decent returns in the years ahead.

A forward 33 per cent discount to NAV simply fails to reflect the likely recovery nor Circle’s impressive track record since IPO in 2016 – total shareholder return of 105 per cent (NAV growth and dividends). A 3.6 prospective dividend yield for the current financial year is attractive, too. Buy.

■ Simon Thompson’s latest book Successful Stock Picking Strategies and his previous book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. The books are being sold through no other source and are priced at £16.95 each plus postage and packaging of £3.25 [UK].

Promotion: Subject to stock availability, both books can be purchased for the promotional price of £25 with free postage and packaging.

They include case studies of Simon Thompson’s market beating Bargain Share Portfolio companies outlining the investment characteristics that made them successful investments. Simon also highlights many other investment approaches and stock screens he uses to identify small-cap companies with investment potential. Details of the content can be viewed on www.ypdbooks.com.