During H120, Palace stepped up its refurbishment and development activity aimed at improving the quality of the portfolio and enhancing its income and valuation potential over the longer term. The flagship Hudson Quarter development is making good progress and the initial tranche of the apartments offered for sale in June has been well received. Although refurbishment and redevelopment activity is dampening current income, DPS is being maintained in anticipation of future income growth and represents an attractive yield.
The property portfolio produced an ungeared total return of 1.5% in H120 compared with 0.8% for the MSCI Quarterly Benchmark Index, benefiting from a focus on regional office and industrial assets. The Hudson Quarter (HQ) development remains on track and on budget and, after initial marketing of 20 apartments in June, 21 apartments have been sold with another seven under offer. Refurbishment and redevelopment are dampening current income and recurring earnings, but adjusted net earnings increased to £3.9m (H119: £3.6m) due to postREIT conversion tax benefits. With capex yet to be reflected in property valuation EPRA NAV fell 3.9% to 391p. Gearing remained moderate at 34%. Mainly reflecting refurbishment plans our forecasts are reduced slightly.
End-H120 estimated rental value (ERV) of £21.2m pa, before the c £0.9m rent potential expected from the HQ commercial assets, is 30% ahead of passing rent of £16.3m pa. This represents a significant opportunity to increase recurring income and underpins the continuation of attractive dividend distributions. Relatively little of this income and value opportunity is reflected in our forecasts although we do include c £10m in development gains in respect of HQ. Similarly not factored into our forecasts, management continues to seek accretive acquisitions for which borrowing headroom exists.
The dividend yield is attractive, more than 6%, and management has committed to the current level of DPS despite a near-term earnings cover shortfall. The discount to EPRA NAV is c 27%. Asset management initiatives to capture reversionary potential and progress with Hudson Quarter are potential triggers for a re-rating.