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Offering a 4% yield, the company has proved resilient to the impact of coronavirus

Who knew German business parks could be so exciting from an investor perspective? FTSE 250 constituent Sirius Real Estate (SRE) has generated a 12.3% annualised total return over the past 10 years from this apparently mundane asset class.

In this article we look at how the company achieves these returns, why the portfolio should be resilient in a post-Covid world and why this makes a sound investment for the long-term.

Sirius' four steps to enhancing value

Sirius enhances rental and capital value through active portfolio management, which can be split into four key stages:

Acquire

It seeks out underutilised, multi-tenanted, mixed-use properties it can transform into higher yielding workspaces.

Transform

It converts properties into improved, more efficient, higher yielding, flexible workspaces. Additionally, its active ongoing programme reconfigures and upgrades existing spaces.

Manage

It seeks to maximise the value of its assets with an active and ongoing asset management programme with most functions performed internally.

Recycle

It sells off mature and non-core assets and uses the proceeds to purchase core assets with higher value-add opportunity.

GERMAN-ONLY FOCUS

Sirius chief executive Andrew Coombs tells Shares the focus on Germany is no accident.

‘The country is resilient. It would be easy to undersell the benefits of the German economy, health system, sense of society and social conscience,’ he says.

Sirius owns and manages 65 sites across Germany – mostly close to its seven largest cities: Berlin, Munich, Frankfurt, Stuttgart, Cologne, Dusseldorf and Hamburg. Its parks were worth a combined €1.19 billion as at 31 March 2020. They are let for a mixture of uses including offices, storage and manufacturing and encompass more than 5,000 individual tenants.

The assets fall into one of two categories: modern light industrial sites typically built since German reunification in the early 1990s and 1930s and heavy industrial assets. Interestingly many of these assets have been occupied by the same businesses for decades.

Coombs says this creates stickiness with tenancies. Feedback from some tenants suggests they would need years to execute a move to another site without disturbing their production lines or research and development processes. ‘One of our tenants (engineering firm) Borsig has occupied its site since 1888,’ Coombs says.

UNDERSTANDING THE MODEL

How does Sirius make money? Coombs explains: ‘Our business model is all about identifying a 25 to 30-year-old business park and buying it for 25% of its replacement cost. The business park is either empty or has a couple of tenants and we invest to turn it into a community of 100-plus tenants. In doing so we take big spaces and subdivide them into higher quality smaller spaces.

‘In effect we are charging a premium for reduction in size. The whole business park we get at a discount and once we split it into 100 parts, the price we sell it at to the tenant is much greater.’

Sirius takes a hands-on approach to managing these assets, having a point of contact on-site and taking care of items like utilities. That makes it more attractive to tenants and enabling Sirius to charge higher service fees.

Thirty percent of the total shareholder returns generated by Sirius comes from dividends, with a policy of paying out 65% of funds from operations (operating cash flow) to shareholders. The other 70% comes from growth in net asset value.

ORGANIC GROWTH IN INCOME

Sirius’ returns could be quite robust in a more uncertain economic environment because they have relatively limited reliance on yield compression – or in other words the value of the assets themselves increasing. Instead returns are driven by the organic increases in rental income it achieves through its investment in the sites.

For this reason, Coombs believes the portfolio could generate annual total shareholder returns of 10% even without any yield compression – leaving it well-positioned for a downturn.

Sirius also sells on mature and non-core assets, recycling the funds back into the acquisition of sites where it can add more value.

RANGE OF TENANTS

Sirius rents to three different types of tenant. Big anchor tenants account for 40% of the revenue and include businesses like GKN, TDK and Amazon.

Micro SMEs (small to medium size enterprises) which are often one or two-man start-up operations contribute 10% and a big middle chunk of SMEs, some 2,500 tenants which fall into the category known as German Mittelstand, make up the other 50%.

In the six months to 30 September the company achieved a cash collection rate of 97.2% despite the pandemic and in line with normal levels. Coombs says plenty of hard work went into achieving that number.

While the big tenants have the knowledge and experience to deal with a crisis and deep enough pockets to keep paying the rent comfortably, and the much smaller businesses have sufficiently modest rental bills they can manage to find the funds in the short-term to muddle through, the middle portion have found life more challenging.

In response Sirius pushed staff resources towards customer liaison, talking to these tenants about the problems they were facing, helping direct them towards sources of state support and supporting the sharing of knowledge across its tenant base.

‘SAFE AND DIVERSE’

On a sector basis, Sirius is well diversified. The largest industry by footprint, the admittedly challenged aerospace segment, represents just 3% of the portfolio. As Coombs explains: ‘We built this portfolio to be safe and secure and ultimately diverse.’

With the market stabilising the company has scope for growth through acquisitions, both by employing the €113 million of unrestricted cash as its disposal and by leaning on its joint venture with asset manager AXA agreed in 2019. It has already sold €70 million worth of assets to AXA and continues to manage them on its behalf.

There is plenty of headroom for growth. Sirius currently has net lettable space of 1.7 million square metres and the market of available assets in Germany is upwards of 300 million square metres.

A strong balance sheet

As at 30 September Sirius holds 12 of its business park assets without any debt, has a net loan to value of approximately 33%, a weighted average cost of debt of 1.5% and interest cover of more than 10 times at net operating income level.

In terms of competition for these assets Coombs says it would, even with his knowledge and experience, take at least five years to get to the point where someone else could replicate the Sirius model and that’s assuming they could get the right people. ‘The concept is quite simple, replication and execution are quite challenging,’ he concludes.

In valuation terms Sirius is not overly expensive given the consistency of its returns and its well-rehearsed and resilient business model.

Based on Panmure Gordon’s forecasts for the March 2021 financial year it trades on a yield of 4% and at a 7.8% premium to net asset value. That premium falls to 2.3% in 2022 based on forecasts for valuations to recover. Buy the shares.

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