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A lack of new supply and robust demand provides opportunities in this market

Anyone visiting or living in London will be aware that office blocks continue to spring up all over the place, with the skyline dominated by cranes as developers press ahead with new projects.

But if you move outside the M25 the story is very different as we explain in this article.

We’ve spoken to Midlands-focused property investor Real Estate Investors (RLE), or REI for short, and Glasgow-headquartered Regional REIT (RGL) about the attractiveness of regional offices as an asset class.

The managers of the two real estate investment trusts say that very few new commercial buildings have been built outside London in the past decade. As a result, there is healthy demand for the already-built stock of offices.

BIG YIELDS ON OFFER

The aforementioned trusts have an appetite for commercial property and offer generous dividend yields in excess of 6.5%.

According to real estate group CBRE, regional offices delivered returns of 11.5% in 2018 against 5.3% for Central London. Rental growth of 2.2% also outstripped the 1.1% achieved in the heart of the capital and rents have typically been more stable in the regions in recent years.

Research from property all-rounder Savills (SVS) shows strong occupier demand is continuing to reduce availability of office space – by 14% across nine key regional office markets in 2018.

Stephen Inglis, chief investment officer at London & Scottish Investments which manages Regional REIT, says: ‘There have been hardly any new developments (outside London).’ He adds that the stock market as a whole has not yet picked up on these attractive supply and demand dynamics to the extent it has in the industrial/logistics space.

MOVING FROM SHEDS INTO OFFICES

The growth of online retail has created demand for warehouses but the clamour for these sites has led some to warn of a ‘bubble’ in the space. Inglis observes: ‘Some of the prices being paid for these assets is unsustainable, often for quite average stock.’

In 2018 Inglis sanctioned the sale of nearly 50% of Regional REIT’s industrial holdings into what he sees as this overheated market.

This included the sale of a portfolio of 15 industrial assets for £39.1m in July 2018 – a sale price which represented a 24.1% uplift against the valuation of the properties as at the end of 2017.

REI has a portfolio of 1.55m square feet in the Midlands where HS2, population migration from London and refocusing
of investors on the regions is driving increased value in property assets.

As chief executive Paul Bassi says: ‘Between us we have more than 100 years of experience of investing in this market and this gives us a significant advantage.’

Both Bassi and Inglis observe that their knowledge of their respective markets and the industry enables them to complete a significant proportion of deals off market and not get involved in auctions where there is arguably a greater risk of overpaying for assets.

THE RESIDENTIAL OPPORTUNITY

Bassi notes that another advantage of regional commercial property is that it often has the capacity to be converted to residential, something made easier by new Permitted Development rules introduced in 2013.

This can result in a material uplift to valuation and REI has earmarked 250,000 square feet of its existing real estate assets as suitable for conversion to residential use.

Investment bank Liberum notes: ‘We believe the outlook for Midlands real estate remains attractive, with REI well-positioned to benefit, particularly should any market dislocation materialise due to political uncertainty or continued negativity towards the retail sector.

‘Improving regional conditions provide the backdrop for further growth in rents, which should enhance REI’s already high income return. Management’s market connections and opportunistic approach also provide numerous additional capital growth angles.’


REGIONAL REIT

Amid some rejigging of the portfolio in 2018 the trust is now more than 70% commercial property with the remainder in a mix of industrial and retail.

The emphasis is very much on providing a secure stream of income so it avoids development assets due to the longer wait for returns and greater risks.

The investment trust also does its own property management, which involves greater costs but, in its view, provides better control of the assets.

Results announced on 28 March revealed a record annual profit of £67.4m, up 149% year-on-year, and net rental income up 19% to £15.4m.


REAL ESTATE INVESTORS

Around 40% of the portfolio is in offices, with a further 30%
split between traditional and discount retail and the remainder is in a variety of different areas like car parks, hotels, bars and coffee shops.

The company looks to be opportunistic and acquires mis-priced assets. It very much sticks to the knitting in terms of geographic exposure with a focus on the Midlands region where management have an edge thanks to their insight and experience.

Its 2018 results showed an occupancy rate of 96.1%, a 5.1% increase in revenue to £15.6m and a 14% increase in the dividend to 3.56p.

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