With the London commercial property sector nearing boiling point, the net is being spread further afield in the search for value – and, by extension, a decent investment return.
According to the most recent reports Saudi and Qatari money is swilling its way along the M1 and M6 out of the metropolis, headed for provincial centres such as Birmingham, Manchester and Leeds.
Here the markets are less competitive and the local economies are buoyant after a period of marking time during and after the financial crisis.
WATCH: Flying under the radar
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While the seeming renaissance of the Midlands and the North may have come as something as a surprise to London-obsessed investors and the media, a small property firm spotted the green shoots of recovery almost four years before the big hitters.
Palace Capital (LON:PCA), headed by industry veteran Neil Sinclair, noted the turnaround in early 2013.
At that point the company was readying to make its biggest acquisition to date, buying a portfolio of regional properties from Quintain, currently spearheading the redevelopment around Wembley Stadium.
It paid £39.25mln for 24 mixed-use commercial properties strewn across England and Wales.
Green shoots
It was in doing the due diligence for that deal, talking to local businesses and commercial letting firms, that it detected the change in business sentiment.
However, it has not all been about being in the right place at the right time.
Palace has also made the most of what it has bought, and this has worked very well for investors.
A case in point was a rather unpromising and sparsely-let retail and office property in Dartford, in Kent.
This was converted under the government’s permitted development scheme at a cost of £2.25m into flats, which were subsequently rented out to the local council under a 10-year agreement.
Making lemonade
This is what the Americans would describe as turning lemons into lemonade.
Anyway, it continues to develop its properties, extending leases and basically adding value.
In York, where it has a 1960s office block called Hudson House, it is following the Dartford blue-print as it aims to redevelop the site for residential and office use.
The latest application to go into the city council is to pull down the building to make way for 127 apartments along with office and commercial space.
Whether it will develop the site itself (if and when permission is granted this summer) remains to be seen given the £30m investment required.
Digging down
Okay, so we’ve gleaned some valuable background on the company.
The first-half results reveal why, from an investment standpoint at least, Palace ticks a number of boxes.
They show its properties generate an average yield of 8%, allowing it to fund a half-term pay-out of 9p (up 29%), which annualised equates to a dividend yield of 5%.
The net asset value grew by 1.2% to 419p; however, the shares (currently changing hands for 360p) have some way to go before they reflect the true worth of the Palace portfolio.
Mentioned above, Sinclair and his team have been excellent at adding value to the portfolio giving scope for decent capital growth.
They have also been adept financially re-engineering assets or portfolios they have acquired.
A good example of this is Broad Street Plaza, in Halifax, a leisure complex with good, long-term tenants such as Wetherspoons, Vue and TGI Fridays.
The former owner had run into difficulties and it owed more money than the value of the property. To add to the problems, there was the looming issue of refinancing.
Palace was able to solve both problems. It replaced the expiring loan with a ten-year deal fixed at less than 3%.
Adding value
Broad Street will generate a rental income of £1.95m in July of this year, or £1.5mln after interest payments. It has minimised the tax on that cash by taking advantage of capital allowances not available to the former owners.
While management are innovative, they aren’t risk takers. So the loan-to-value is around 39%. Halifax, meanwhile, isn’t a one-off in so far as Palace’s average cost of debt is 2.9%.
Recent asset sales, done well in excess of book value, suggest the valuation of the properties owned by the group may be on the conservative side.
More to the point analysts estimate these disposals have added around 9p to the last published net asset value.
So, what next? Palace has a supportive investor base that includes Schroders, Polar Capital and George Soros’s Quantum Partners.
It has raised around £63mln in three tranches starting at 200p, the 310p and finally 360p. Its backers are on board if the right opportunity comes along.
However, caution is the watchword. “The market is very tight at the moment and we don’t want to overpay,” says Sinclair.
“We won’t be going to shareholders unless the deal is really worth it.
“Instead of one big deal, we may look at doing a number of smaller ones.”