The hidden detail behind Regional Reit's 17% yield

Of these, four are in active wind-down, realisation or rollover, another (Home Reit (HOME)) is indefinitely suspended, while a sixth, Hipgnosis Songs (SONG), is in crisis after shareholders voted against extending its investment mandate in October. Huge uncertainty also characterises Chrysalis Investments (CHRY), which will soon hold its own continuation vote after a torrid run, and Digital 9 Infrastructure (DGI9), which in November sold its most valuable asset and launched a strategic review.  

That leaves six, of which four typify the now-familiar market stand-off around the valuation of illiquid private equity assets, and a fifth, Ceiba Investments (CBA), is probably shunned because its chosen real estate focus is in one of the world’s only one-party Marxist–Leninist states, Cuba.

But should deep value hunters waste time on the last name in the line-up, Regional Reit (RGL)? While a deeply unfashionable play on UK offices hardly inspires confidence, one of the stock’s hooks – a 15.5 per cent target dividend yield – is sharp enough to reel in even the most embittered cynic.

Some see that monster payout ratio, trimmed last year to reflect slimmer earnings, as sustainable. Last week, the latest 1.2p-a-share quarterly distribution was made to investors, and the Reit’s board cites “maintaining the quarterly dividend” as a dual priority, alongside a “controlled disposal programme” to reduce the portfolio’s net loan-to-value ratio back to a long-term target of 40 per cent.

Problem being, leverage has been trending in the opposite direction. At the end of September, net debt stood at £396mn, equal to 52.6 per cent of gross property assets (independently valued in June, but adjusted for capital expenditure, purchases and sales in the subsequent three months). A year prior, the ratio was at 43.1 per cent, up slightly from 42.5 per cent at the end of September 2021.

Fortunately, a legacy of pre-pandemic fundraising means debt costs are still low, at least for now. A £50mn bond, assigned a fixed coupon of 4.5 per cent at its issue in 2018, matures in August. Assuming cash levels have held since November, then this is still around £20mn shy of what’s needed to make bondholders whole – though Regional’s directors have stated their belief that “appropriate borrowings will be in place in adequate time” if refinancing is needed when the bond matures.

The odds of righting the balance sheet will improve if disposals can gather momentum following November’s sale of a Glasgow office and leisure complex at a 26 per cent premium to an independent June valuation. At £6.25mn, the price tag represented a baby step in the deleveraging effort, and something of an outlier, given the year’s remaining £19.8mn-worth of asset sales have come at a slight discount.

This brings us to the second big problem: the question of who wants to own (or rent) an office in 2024. Leasing appetite is hard to read. While Regional Reit has reported strong renewal activity and resilient estimated rental values, rental income has contracted as some tenants have vacated and others have dragged their feet. As of September, occupancy was 80.7 per cent, versus 89.4 per cent at the end of 2019.

Regional’s board appears defiant. When it reduced its 2023 dividend target from 6.6p to 5.25p last September, it acknowledged both the tough trading conditions and a then-implied yield of 19.2 per cent.

While that might seem reckless, the trust could counter that it is the share price that is wrong, and that its Reit status – which requires it to distribute 90 per cent of net income to remain tax-exempt – compels it to play the (extraordinarily) high yield card.

Then again, the alternative isn’t too bright. Go hard on disposals to scythe those borrowings, and writedowns are likely. So too with rent cuts. But the long-term outlook for the Reit’s asset base is a worry, too. Sometimes, even the most tempting offers come with nasty hidden clauses.