Elite UK REIT - Room for positive asset repricing

Initiate coverage with a BUY Rating

Elite UK REIT (Elite) owns 150 office assets located across the United Kingdom with total internal area of 3.8m sq ft valued at £415 million. 

More than 99% of the space is leased to the UK Government on triple net basis, where tenant is responsible for capex and dilapidations if they do not renew leases at expiry. 

Rents are reviewed every five years based on the UK Consumer Price Index (CPI), subject to minimum of +1.0% and maximum of +5.0% per annum. 

The Department for Work and Pensions (DWP) filled 93.5% of the occupied space.

The REIT manager is Elite UK REIT Management Pte Ltd, owned by sponsors Elite Partners Holdings Pte Ltd (68%), Sunway RE Capital Pte Ltd (15%) and Jin Leng Investments Pte Ltd (17%). 

Elite Partners has given Elite a right of first refusal to the UK assets held in a private fund that it manages.

About 96.9% of its leases are expiring in FY28

As at Jun 24, Elite enjoyed a high portfolio occupancy rate of 92.3%. However, a substantial 96.9% of the leases will expire in 2028. This, we believe, is weighing on the value of its assets and share price. 

The manager is in discussion with DWP to extend and diversify leases. As Elite is amongst the largest providers of critical social infrastructure to the DWP and other government departments, the risk of non-renewal for all leases is remote, in our view, though it is difficult to say for sure how many will be renewed. 

For the lease at Dallas Court, Salford that is expiring in 2024, Elite entered into a fresh 10-year lease at about 30% rental uplift. The expiring lease at Cardiff is extended to March 2025.

Potential for asset value appreciation

There is room for an appreciation in the value of its assets, in particular when the leases are renewed. The portfolio generated gross yield of 9.2% in FY23, a 4%-point carry over SONIA, and 0.9%- to 5.8%-point above prime yields in various UK regions. 

Rental income was stable despite the disposal of five assets and lower overall occupancy of 92.3%. FY23 NPI yield at 10% (FY22: 7.8%) is one of the highest amongst Singapore-listed REITS. 

Yield compression on lease renewal and declining interest rates would lift value. Elite has also expanded its mandate to include other asset classes. 

A conversion to residential use would boost valuation.

More rate cuts with improving macroeconomic environment 

Bank of England (BOE) had its first rate cut post pandemic, by 0.25%-point, on 1 August, as August inflation eased to 2.2%. Though still above BOE’s 2% target, this gives room for further rate cuts. 

We expect a further 0.25%-point cut in 4Q24 and 1%-point in FY25. GDP growth picked up in 1Q24 to 0.3% (FY23: 0.1%), and we expect 1.1% growth for FY24. 

Lower interest rates would reduce borrowing costs and raise distributable income. 

Our target price is £0.44

We derived a target price of £0.44 based on the dividend discount model, on weighted cost of capital of 11.2% and 3% terminal growth rate. 

At this price, the yield is 7.0% and 7.8% for FY24E and FY25E, respectively.

Elite is currently trading at price to book of 0.78x, and distribution yield of 9.8% for FY24E and 10.9% for FY25E. The yield is highest amongst the European-focused REITs listed on SGX.

Potential risks include leases not renewed or extended beyond 2028, and if the upcoming UK Budget raises the cost of property ownership.

Download the full report here. 

Related Links:

• Elite UK REIT share price history and share price target
• Elite UK REIT dividend history and dividend forecasts

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