The PRS REIT (PRSR LN) – Safe as houses?

The PRS REIT (PRSR) looks to address the imbalance between the supply of and demand for housing in the UK. The Conservative government has a target of 300,000 new homes a year in England alone, a level of annual housing output that has only been achieved six times since the Second World War. The latest ONS data show that there were only 145,430 completions in England in the 12 months to end-September 2020.

While there is a shortage of supply generally across the housing market, there are particular challenges in the rental market, where many small-scale landlords have exited the market in recent years, motivated by tax and regulatory changes. This creates a gap in the market and, importantly, a market in the gap for professional landlords such as PRS REIT.

The PRS REIT specialises in professionally managed high quality family rental homes. It has a scalable business model that delivers these new homes across multiple geographies and sites, utilising the Investment Adviser (Sigma’s) property delivery and management platform. Sigma selects the development sites, obtains detailed planning permission and engages the construction partners. House designs have consistent specifications and delivery is through fixed-price contracts. Standardisation offers economies of scale in both construction and subsequent asset management. PRSR is also a preferred partner for construction companies, as they prefer to deal with a deep pocketed buyer of multiple units that facilitates the faster recycling of capital. PRSR also partners with local authorities wishing to address housing lists.

PRSR mitigates concentration risk through geographic diversification (major towns and cities in the UK, predominantly England, excluding London) and a strong bias towards the development of houses as opposed to apartment blocks. Its focus on building sustainable communities and service means that average tenancy terms are expected to be three years, reducing voids.

For investors, PRSR seeks to provide them “with an attractive level of income together with the prospect of income and capital growth”.

The PRS REIT (PRSR) had its IPO in May 2017. Its gearing limit is 45% (although Sigma guides to 35-40% following stabilisation) and following first admission, the Group targeted a dividend yield of 5% (a 5p DPS based off the £1 issue price). The Group raised gross proceeds of £250m from its IPO, with a further £250m (gross) raised in a placing in early 2018. The Group augmented this with debt capacity to give an investment capacity of ~£900m.

The Group has steadily grown its portfolio of completed homes since its establishment. At end-FY18 (year-end June), the Group had 405 completed homes. This rose to 1,173 at end-FY19, 2,082 at end-FY20 and 3,984 at end-FY21.

The ERV of the portfolio has grown in tandem with the in-place portfolio – £3.6m at end-June 2018, £10.7m at end-June 2019, £19.1m at end-June 2020 and £37.5m at end-June 2021.

On dividends, the Group paid 5p in respect of FY18 and FY19. This was reduced to 4p for FY20, reflecting uncertainty regarding the impact of COVID-19 on the delivery schedule. Management maintained this payout level (i.e. 4p a share) in respect of FY21.

As mentioned above, at the end of June 2021 PRSR had a portfolio of 3,984 completed homes with an estimated annual rental value of £37.5m at that date. A further 1,071 housing units were under construction at that date.

Since the start of the current (FY22) financial year there have been a number of developments of note.

On 16 July, the Group completed its 4,000^th unit. A trading update in September showed that the portfolio had grown to 4,227 completed units by end-August with an ERV of £40.3m as at that date, with a further 828 units with an ERV of £7.7m under development. On 27 September the Group announced its intention to conduct a placing to raise gross proceeds of up to £75m with the intention of adding further sites to the development portfolio. This placing did not go as well as management had hoped, with gross proceeds trailing in at a disappointing £55m. On 15 December, PRSR said that it had deployed the proceeds from this placing, securing three new sites with a combined gross development cost of £60.3m which are expected to deliver 383 new homes with an ERV of £3.6m. The first of these homes will be available to rent from the end of February. A further two target sites will be acquired, using debt funding, during the first half of calendar year 2022. On 12 October, PRSR announced that at end-September its portfolio stood at 4,291 completed units with an ERV of £41.1m with a further 764 contacted units with an ERV of £7.0m as at that date.

As a side note, as previously set out, the portfolio is quite well diversified within the UK. By value, the split at end-June was 56% in the North West, 18% in the West Midlands, 13% in the South East, 9% in Yorkshire, 3% in the North East and 1% in the East Midlands. Since the start of FY22 the Group has entered the Scottish market. ERV of £48.1m for 5,055 completed and contracted units at end-September implies average rents of c.£9,500 a year / c.£800 a month for the portfolio. ONS data show that the median rent across England in the period to end-September 2021 was £755. So, the PRSR portfolio looks well positioned as: (i) you’d expect brand new homes to command a premium over the blended in-place stock; and (ii) the premium is not so high that you’d be concerned if there were any economic speed bumps ahead. Occupancy across the portfolio was 98% at end-September.

Taking the latest (December) site acquisitions and adding them to the end-September (Q122) actuals, the Group has a portfolio of 5,438 completed and contracted homes with an ERV of £51.7m. The gross-to-net ‘walk’ reflecting non-recoverable property costs is about 20%, so net rental income on the completion of development assets should be £41.4m. Take (say) £6.4m off that for admin costs and a further (say) £10m off for net finance costs. That gets you to £25m of underlying earnings, which equates to around 4.5p a share, leaving plenty of headroom between the current 4.0p annual dividend if I’m being too generous on the cost lines. If I’m in the right area on operating and finance costs, then management could easily up the dividend to 4.25p or possibly 4.5p a share.

Based off the current 110p share price, a 4p dividend gives a yield of 3.6%, a touch above the FTSE All Share yield of 3.5%. The granular nature of the portfolio (5,438 income producing units on completion of the pipeline) and modest gearing (a maximum of 45%) provide reassurance on the income line. It seems reasonable to assume that the dividend will grow over time in inflation adjusted terms (given the trend in real earnings), due to the large imbalance between housing supply and demand. The latest NAV per share is 99.0p, a fraction below the admission price (reflecting dividends paid out in the earlier stages of PRSR’s development, when rental income was only starting to scale up), but I’d expect it to grow from here as dividends are covered by earnings and the Group benefits from rising property values. For me, PRSR is a nice secure income stream for my portfolio, and for that reason I am happy to be long it.

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