Strengthening its portfolio
? Enters into lease re-gearing agreements, sustainability-linked collaborations.
? These will likely strengthen the income visibility and sustainability metrics of its portfolio in the medium term
? Reiterate Add with an unchanged DDM-based TP of £0.76.
Boosting portfolio income resilience and sustainability
Elite Commercial REIT (ECR) announced it has entered into separate agreements with The Secretary of State for Levelling Up, Housing and Communities of the United Kingdom, to regear certain leases of its properties occupied by the Department for Work and Pensions (DWP). In addition, ECR has also agreed to collaborate on certain sustainability-linked investments for properties occupied by DWP.
Lease re-gearing extends portfolio income visibility
DWP occupies 117 ECR properties, accounting for 57.3% of its total portfolio GRI. The leases have a break option in Mar 2023. Under the current conditions, if the break option is not exercised, the lease is confirmed to run continuously until Mar 2028 with a built-in inflation-linked rental escalation clause. Under terms of the Lease Re-gearing agreement, the lease break option has been removed from 100 of the 117 properties. The 100 properties make up 47% of total portfolio GRI. This, together with an additional 31.6% of GRI with straight leases till 2028, will mean that a total of 78.6% of ECR’s GRI will expire only in 2028F, without any lease break option. This will extend ECR’s income visibility significantly, while it still benefits from the inflation-linked escalation clauses. Under the re-gearing agreement, the remaining 11 of the 100 properties (5.3% of total portfolio GRI) will have rent reductions that will take effect from Apr 2023. That said, management indicated that the net impact of the re-gearing will
likely result in a positive upside to ECR’s earnings in 2023F, despite the rent reduction. Post adjustment, removal of the break clause will not only lengthen ECR’s income visibility, it would likely have a positive knock-on impact on portfolio valuation. This could lower its gearing, which stood at 42.4% at end-Dec 2021.
First sustainability collaboration with DWP
In addition, under the terms of the agreement to collaborate on certain sustainability-linked investments for properties occupied by DWP, ECR will commit to invest £12.5m over three years, to undertake asset enhancement works across the assets to target sustainability and climate adaptation requirements. This is in line with the UK government’s commitment to achieve net zero carbon emissions by 2050. The works could include repair, replacement or upgrading of lighting systems, heating and cooling systems, insulation and solar panels, and other initiatives. This could improve the sustainability and energy efficiency credentials of the properties occupied by DWP within the portfolio.
Reiterate Add
We keep our FY22-24F estimates and DDM-based TP of £0.76 pending more details on the agreements. At current price, ECR offers an attractive FY22F dividend yield of c.7.7%. We like ECR’s stable income portfolio, with inbuilt growth through its inflation-linked rental structure. Potential re-rating catalysts could come from rental uplifts for the majority of its portfolio in FY23F, while downside risks include tenant concentration exposure to the DWP.