A change of strategy by property debt specialist Real Estate Credit Investments (RECI) in reaction to tougher conditions for buyers of mortgage-backed securities (MBS) has helped illustrate the value of its relationship with leading alternative investment management firm, Cheyne Capital. And an improved dividend policy, which means investors can expect a 6.5 per cent yield from the shares, makes RECI a worthy buy for income-hunters looking to cash in on improved conditions in the European property-lending market.
- Attractive dividend
- Solid return from bond portfolio
- Expanding property loan portfolio
- Efficient use of capital
- Vulnerable to deterioration in credit market
- Narrowing discount on bonds
Until recently, RECI's portfolio of UK and Western European residential and commercial real-estate debt was primarily focused on MBS investments. These assets have performed very well over recent years, delivering an 11 per cent gross return in the 12 months to March alone. Unfortunately, the strong run means it has become increasingly hard to pick up bonds at the chunky discounts once on offer. Indeed, last year the average purchase price across RECI's portfolio rose from 72 per cent to 81 per cent of par and the weighted average expected yield to maturity fell from 14.9 per cent to 9.9 per cent.
However, RECI's management company, Cheyne Capital, has many strings to its bow, which means RECI has been able to hunt for higher returns elsewhere. The fund has shifted towards lending directly to property companies. So while the bond portfolio last year grew from £75.4m to £85.8m, the loan portfolio jumped from £20m to £51m.
RECI's allocation to loans was boosted last November with a £50m placing, at which time the dividend payout policy was also made more generous (a 7 per cent target yield based on a 152p placing price) to reflect the proportionally lower running costs of the enlarged fund. The loan portfolio now comprises 10 investments, which adding on investments in the pipeline, would bring total commitments to over half of gross assets. The weighted average yield across the loan portfolio at the end of May was 13.7 per cent, with a weighted average loan-to-value ratio of 72 per cent.
| REAL ESTATE CREDIT INVESTMENTS (RECI) | ||||
|---|---|---|---|---|
| ORD PRICE: | 167p | MARKET VALUE: | £122m | |
| TOUCH: | 165-167p | 12-MONTH HIGH: | 168p | LOW: 140p |
| FWD DIVIDEND YIELD: | 6.5% | FORWARD PE RATIO: | 11 | |
| PREMIUM TO FORWARD NAV: | 3% | |||
| INVESTMENTS: | £137m | NET DEBT: | 21% | |
| Year to 31 Mar | Net asset value (p) | Pre-tax profit (£m) | Earnings per share (p) | Dividend per share (p) |
|---|---|---|---|---|
| 2012 | 110 | -0.7 | -2.0 | 4.64 |
| 2013 | 150 | 19.0 | 47.6 | 7.4 |
| 2014 | 154 | 8.1 | 15.4 | 10.2 |
| 2015* | 158 | 10.5 | 14.4 | 10.8 |
| 2016* | 162 | 10.9 | 15.0 | 10.8 |
| % change | +3 | +4 | +4 | - |
Normal market size: 3,000 Matched bargain trading Beta: 0.12 *Liberum estimates | ||||
RECI's manager is particularly keen on mezzanine loan opportunities, which have an element of equity-related upside but, in the case of the borrower going under, are subordinate to the claims of standard senior mortgage lenders. However, RECI can mitigate some of these risks by leaning on the underwriting strength and depth provided by Cheyne Capital's wider real estate funds, which have £1.2bn of real estate assets under management.
What's more, Cheyne can write a whole loan and sell senior tranches into a competitive market, while retaining the more lucrative but riskier mezzanine tranche. This means Cheyne can impose stricter mezzanine covenants that are breachable prior to those on the senior loan, placing RECI in a much stronger position in the event of a default. The combination of the two revenue drivers, bonds and loans, provides an additional lift because the managers can buy and sell property backed bonds in the secondary markets.
The structure of RECI is important in understanding the attractions and risks of its shares. The company both preference and ordinary shares. The prefs (RECP), which readers may also want to take a look at, are listed on the London Stock Exchange with a coupon rate of 8 per cent and mature in 2017 and represent a £42m liability for RECI. Much like conventional debt, the fixed-term financing provided to RECI by the prefs has the effect of magnifying the impact of movements in the underlying investment portfolio on the ordinary shares. A further class of 'Cell' share, called European Residual Income Investments, relates to a €2.3m legacy portfolio.
