While using the GuruFocus All-in-One Screener to search for significantly undervalued stocks, I came across UK Commercial Property REIT Ltd. (LSE:UKCM, Financial).
A quick search showed this real estate investment trust’s net asset value was 1.11 pounds ($1.39) per share on March 31. The stock traded at 0.85 pounds per share at the time of writing, a 23.6% discount to NAV. The Piotroski F-Score of six out of nine was also a confidence booster.
I am quite interested in REITs because in addition to generating decent income and asset growth, they also offer some inflation protection. UK Commercial Property REIT describes itself as a diversified portfolio of high-quality real estate built for the future. A FTSE 250 constituent, the company is one of the largest diversified REITs listed in London and is managed by Abrdn PLC (LSE:ABDN, Financial).
Over the past year, the fund has been repositioning its portfolio toward modern economy property sectors. Following an important transaction in March of last year, Will Fulton, lead manager of UK Commercial said in a stock exchange statement, "This latest disposal is in line with our ongoing strategy to focus our portfolio on modern economy, future fit, property sectors and assets that benefit from structural changes in the way we interact with real estate. We remain a diversified portfolio, strongly weighted to the industrial and logistics market, and continue to look for opportunities to deploy capital."
Currently, 63.4% of the portfolio is invested in industrial assets, where demand has been strong, and just 3% is invested in standard retail properties.
Rent collections proved robust during Covid-19 pandemic, falling to 83% in 2020 but rising back to 97% in 2021, which was also 2019’s level.
The REIT is relatively focused, owning only around 40 properties, giving the average value of about 40 million pounds. Looking into the portfolio, these properties are mostly large and good-quality assets, meaning the yield of the portfolio is lower than average due to the lower risk.
In terms of tenants, UK Commercial has around 200 different commercial tenants. The company's largest tenants are corporations like Ocado Group PLC (LSE:OCDO, Financial), which makes up 5.1%, followed by Warner Bros. Discovery Inc. (WBD, Financial) at 4.6% and Amazon.com Inc. (AMZN, Financial) at 4.4%. Another 5% of the REIT is leased to government entities. Given its tilt toward logistics assets, any lost tenancies will be quickly replaced.
UK Commercial has also bought several assets in recent years, which have substantial growth potential. This includes a 94 million pounds life sciences business park in Leamington Spa, which is dedicated to being one of two "megalabs" aimed at increasing Covid-19 testing capacity in the U.K. and developing the country’s diagnostic capabilities more broadly for other critical illnesses.
The REIT also purchased three warehouse units near London’s Gatwick Airport at the end of last year. These are still under construction, but are expected to generate an attractive development yield of 5.8% a year. This compares well to tenanted industrial assets in the secondary market, where yields are typically below 4%.
A strong performance in 2021 supported a 16% increase in the latest quarterly dividend. While a difficult economic outlook could mean some tenants might fight rent increases in 2022, rental growth forecasts in the warehouse sector are around 7% in the U.K. this year. For prime locations such as London, rental growth is expected to be closer to 20%. All these developments give the board confidence its dividend is sustainable, even while it invests in development projects. Indeed, the first quarter saw a dividend cover of 101%.
In terms of lease-based inflation protection, only 26% of rental income is index-linked or on fixed uplifts. But this is not a bad thing given the high exposure to industrials where it is – and indeed has been – better to be exposed to open-market rent reviews, which have been rising well ahead of inflation in recent years.
UK Commercial’s reversionary yield (the yield if all properties were relet at current market rates) was estimated at 8.7% in the fourth quarter of 2021. Additionally, with around 20% of leases expiring in the next three years, there should be leeway to raise rents and help keep income ahead of inflation.
The REIT is also conservatively managed and has one of the sector’s lowest loan-to-value ratios, which gives me a lot of comfort with a possible recession on the horizon. Many REITs got smashed in the last financial crisis as they had too much leverage. Additionally, its debt maturity profile is medium-term, so there is no significant refinancing risk in the next few years.
Finally, insiders are buying. Three of UK Commercial Property's directors have increased their holdings so far this year.
In conclusion, while this REIT is not going to make you rich, it is a good diversifier with a cheap valuation and managed for financial strength and stability. As such, the stock is well worth considering.
