Palace Capital has completed the previously announced £20m acquisition via a corporate deal, more than replacing rental income from disposals made in FY17. The new assets are fully let at a higher yield than our previous estimates. This leads us to raise our forecasts slightly and provides scope for rental and valuation uplifts in future, in line with Palace’s strategy of providing capital growth as well as stable income.
The company Palace has acquired owns a mixed-use, modern, office, residential, hotel and retail development in central Newcastle, with two floors of a multi-storey car park as well. The new assets’ annual rental income of £1.765m represents a net initial yield of 8.6% on the £20m acquisition price after costs, which compares well with the rest of the portfolio at c 7.5% on average. It is expected that the next speculative office development in Newcastle will not be ready for two years, and occupier demand has been strong in recent months – favourable dynamics for rental markets in the area.
The acquisition aims to fulfil both Palace’s aims of providing capital value increases and a rising dividend supported by a stable rental portfolio. There is potential for increased rents, with current rates c 15% below prime rates for Newcastle offices according to local property consultants, which, if achieved, could lead to higher valuations too. The 8.6% yield may also come down if investor demand in the regions rises; London offices are widely expected to lose value over the next two to three years and investors may seek income-producing assets in areas where higher yields provide attractive returns, protection from cyclical changes in the property market and less exposure to Brexit-related risks. Finally, following the disposal of £12.6m of assets in FY17 (including a £3.4m valuation gain), the new investment also shows Palace’s ability to recycle capital efficiently, with the new income more than offsetting rent on the properties sold.
Palace’s 17% discount to 31 March 2017 EPRA NAV of 443p is well above the peer average (4% discount) and seems high even allowing for development risk on some of its assets. High yields and the regional focus provide some risk protection and the 19p FY18e dividend (5.1% yield) may add to the shares’ attraction. Our forecasts indicate 1.28x cover in FY19, or possible scope for a higher distribution.