Shaftesbury plc (SHB LN) is a £2.4 billion real-estate investment trust (REIT) with a virtually impossible-to-replicate portfolio of ~600 mixed use buildings that extends over 16 acres in the hearth of London’s West End, for a total of 1.9 million square feet of commercial and residential space (plus an additional 0.3 million square feet in the Longmartin joint venture).
Located between the Central Business District’s large upper-income working population on one side and affluent residential neighbourhoods on the other, real estate in the West End benefits from a structural imbalance between availability of space and demand. This historic advantage has resulted in the area’s development as a strong domestic and overseas tourist destination: in normal times it draws over 200 million visits annually. The bedrock of this footfall are however Londoners, its huge working population and daily domestic leisure visitors.
Shaftesbury’s strategy has always been to invest in iconic locations which suffered from fragmented ownership and the lack of a coherent strategy: it is able to unlock rental and capital value by establishing clusters and influencing the portfolio of tenants in a location to optimise its desirability.
History and shareholders
Founded in 1986, Shaftesbury began pursuing a West End focused strategy when their modest holdings in the area saw sustained tenant demand and cash flows during the property recession of 1990-1993.
Starting in 2014 Samuel Tak Lee, a Hong Kong billionaire who already owned vast swathes of commercial property in London's West End through Langham Estate, began accumulating a stake reaching 25% in early 2018: at that year’s AGM, Mr. Tak Lee voted against several resolutions that would have taken power away from large shareholders (for example granting directors authority to disapply pre-emption rights in connection with an acquisition), a move widely seen as a precursor to a potential bid for the entire company.
Norges Bank Investment Management, which manages the Norwegian sovereign wealth fund and had been a shareholder since at least 2011 (when it was revealed it crossed the 3% reporting threshold for the first time), also increased its stake to over 22% by buying out Invesco’s at a price of £9.70. Norges, which also holds a 25% stake in London’s Regent Street (with the rest held by the Crown Estate, a collection of lands and holdings in the UK belonging to the Queen), was however not preparing a full takeover and acquired the additional shares “as a sign of shareholder solidarity in the wake of the disruption”.
In the end, the hostile bid never materialised and in June 2020 Mr. Tak Lee sold its stake (26.3%) for £436m to Capital & Counties (Capco), another London-listed REIT with commercial properties in Earl’s Court and Covent Garden.
Today, Norges and Capco have similar stakes at ~25% each, with the rest being free float.
Current portfolio
The current portfolio is split 2/3 over hospitality/leisure & retail and 1/3 offices & residential. The mixed-use buildings typically comprise restaurants, shops, cafés, bars and pubs over lower floors with offices, residential or a mix of both on upper floors.
Hospitality and leisure
325 restaurants, cafés and pubs
Value: £1.1bn
Leases (new): typically 15 years with turnover-related top-ups
Retail
283 shops
Value: £0.8bn
Mid-market, independent brands, rather than national chains: a mix of fashion, footwear, accessories, health & wellbeing, lifestyle
Wide range of shop sizes and rental tones: flexibility for retailers to expand or introduce new concepts
Leases: typically 3-5 years
Offices
313 suites
Value: £0.5bn
Small, flexible and affordable accommodation: range of office sizes provides opportunity for occupier expansion
High occupancy and good retention rates
Typical occupiers: media, creative, fashion and tech businesses
Leases: 2-5 years
Residential
633 apartments
Value: £0.5bn
Mostly mid-market apartments (studios, one or two-bedrooms), largely unfurnished
Occupancy traditionally high (>98%) so reliable cash flows
Lease rather than sell: retain control over whole buildings to not compromise long-term value creation opportunities over lower floors
Leases: 3 years with rolling break options after six months
There is a long history in these areas of demand exceeding the availability of space, which often is restricted by conservation legislation. This limits the opportunity for large-scale redevelopment to materially increase the supply of new accommodation, particularly at lower-floor levels. Consequently, Shaftesbury’s portfolio has historically benefited from high occupancy levels and growing income.
In addition, owning such concentrated clusters bring opportunities to add further value by implementing cohesive, long-term strategies, for example by combining adjacent buildings to rationalise and improve the offered space. The benefits of individual improvements, such as increased footfall and spending, compound across all nearby holdings, driving long-term growth in rental and capital values at modest outlays.
An experienced management team
With the headquarters in Carnaby (a 15 minutes’ walk to all the holdings), SHB is run with just 54 employees and led by an experienced management team where senior managers have an average length of service of 16 years.
The CEO Brian Bickell joined in 1986, was appointed Finance Director in 1987 and CEO in 2011: as such, he has been a director and board member for almost 35 years. Chris Ward arrived as his replacement as CFO in 2012, while the two other Executive Directors joined in 1987 and 1989, respectively, and have both been board members since 1997 (24 years!). They split their areas of responsibility, with Simon Quayle taking care of the asset management and operational strategy in Carnaby, Soho and Fitzrovia and Tom Weldon doing the same for Covent Garden and Chinatown.
Their compensation packages are not excessive (at least compared to US companies): in 2021 the CEO was paid a base salary of £550k, while the other three top managers each got something less than £400k. All of them can get a maximum annual bonus of 150% of salary, with 50% deferred into shares which vest after a three-year period. The performance measures to determine the bonuses represent a mix of financial, operational, sustainability and corporate objectives.
However, the Remuneration Committee has quite a lot of discretion in granting annual bonus awards, which should fairly reflect overall performance in the context of prevailing general economic and property market conditions: it’s not infrequent that the Committee exercises its discretion in reducing how much is accorded in any given year.
Finally, executive directors are expected to build a shareholding of 200% of salary to be accumulated over five years from appointment. Collectively, they own ~1% of the outstanding shares, worth £23 million at current prices.
Brexit and Covid: a double-whammy
Any discussion can hardly avoid mentioning the two elephants in the room, namely Brexit and Covid.
Shaftesbury’s shares were already down -20% in 2018, when it became clear that the promised bonanza from Brexit was illusory and the divorce from the EU was going to be messy and costly for UK businesses. That could have been manageable - and hopefully transitory - once the papers had been signed, but then in 2020 Covid struck. Over the last 18 months (Shaftesbury’s fiscal year ends in September so the latest annual report is from 09/2021), in common with many cities London has experienced lengthy lockdowns and social distancing restrictions (including the valuable festive trading period) and only 2-3 months where businesses have been able to trade at full capacity and offices reopen.
As every landlord around the world, SHB was faced with tough decisions on what to do with their tenants. The answers have been tailored to individual occupier’s needs and included a mix of waiving/deferring rents, drawing against rent deposits, extending lease tenures, digital marketing initiatives and providing additional outdoor seating capacity where possible. Despite Government financial assistance and their own initiatives to support occupiers, there was inevitably an increase in business failures and the handing back of space across the entire West End.
SHB’s strategy of delivering growth in annualised current income and rental values obviously came to a stop. Recent results show that, inevitably, net property income decreased both in FY 2020 (-24%) and FY 2021 (-13%) because of reduced occupancy, the rental support provided and charges for expected credit losses. In total, the 18-months of pandemic dislocation resulted in a 34% decline in annual net property income. [The first chart on the left shows whether commercial leasing transactions during the fiscal year were concluded above or below the Estimated Rental Value – ERV].
Occupancy levels dropped, with vacancies reaching almost 10% on average over the last 4 quarters and properties staying vacant for longer periods: high occupancy and letting property quickly are key factors in sustaining good cashflows from any real estate portfolio. While far from full recovery, occupancy levels have started to improve again in H2 2021 and are returning to long-term averages across all uses: tailored occupier support has been successful in maintaining occupancy.
With conditions improving as restrictions were lifted, the company’s financial support began to taper and was largely withdrawn from October 2021: rent collection improved markedly since “Freedom Day” (July 21) and new leasing activity accelerated with over £30m of lettings and renewals. SHB also continues to collect arrears, with the eventual full recovery of amounts depending on tenants’ future income generation.
The trend to return to pre-Covid vacancies and net property income levels is well under way!
A strong and very liquid balance sheet
Shaftesbury has total assets of £3.4bn versus total liabilities of less than £1bn (of which only ~£30m are current liabilities). With over £200m in cash and cash-equivalents in hand (plus an undrawn floating rate revolving credit facility of £100m bringing available resources to over £300m), it can easily meet its current liabilities and retain purchasing power to invest in new assets or improve current ones.
Traditionally, it has operated with very conservative leverage levels with long-term fixed interest arrangements forming the core of its debt finance. The loan-to-value (LTV) ratio only increased above 30% in 2020 as a direct consequence of the pandemic: to better weather further extended periods of uncertainty, the LTV ratio was brought back to 25% in 2021 with a £300m equity issue in November 2020, the impact of which was partly offset by further decreases in the portfolio valuation in 2021. The capital increase also allowed to release £252 million of charged properties, bringing the pool of uncharged assets to £686 million.
While slightly up, the blended cost of debt only increased to 3.1% during last year, and it’s on par with the last few years. Interest cover (calculated before investment property disposals and valuation movements) decreased from 1.9x to 1.4x largely due to lower net property income. Obviously, this is a critical metric to monitor going forward as is the total cost of debt due to the current macro situation (inflation and higher yields), but this should be offset by potentially higher income from rents as well.
Much more important, there are no liquidity issues at all: the earliest debt maturity (one year from today) is an undrawn RCF for only £100m, and discussions regarding its refinancing have already commenced. The first mortgage bond matures in 2027, while the term loans are further away (2029 and 2030), giving the company a weighted average debt maturity of 8 years. Needless to say, SHB is fully complaint with all its debt covenants.
With the implications of the pandemic on the company’s business becoming apparent, and in order to preserve cash, in March 2020 SHB suspended its strategy of progressive growth in dividends for the first time since it floated in 1987 and cancelled both the final payment for the previous year and the interim payment for the current year. In May 2021, with conditions improving, it declared an interim dividend of 2.4 pence, although the primary reason was to remain compliant with the REIT legislation (obligation to make a distribution in respect of previous year’s profits, calculated by reference to tax rather than accounting rules).
Valuation
At 30 September 2021, the portfolio was valued at £3.0 billion, the first increase in the semi-annual assessment for a couple of years, for an equivalent yield of 3.9%. [Equivalent yield is the IRR from a property based on the gross outlays for its purchase and reflecting reversions to current market rents]
Over the last 20 years, Shaftesbury’s share price has traded wildly around its NAV, with the discount increasing after “market crashes” (Internet bubble, Great Financial Crisis and Brexit/Covid) and trading at a premium in more “relaxed” times (for its characteristics of a pure-play REIT). Curiously, it didn’t trade at much of a premium in late 2017 – early 2018 when both Tak Lee and Norges were building their stakes.
Today the share price is right on par with NAV, which – at least in my opinion – is less a function of the stock being expensive and more because the current NAV is backward looking and still depressed (and reflect the increase in shares outstanding following the capital increase). I personally don’t like much “betting on recovery plays”, but undoubtedly both SHB’s NAV and share price are closely linked to the returning of more normal economic conditions (at least in the short term).
[Note: in 2020 the European Public Real Estate Association (EPRA) decided to “replace” the NAV and NNNAV measures with three new valuation metrics: Net Reinstatement Value (NRV), Net Tangible Assets (NTA) and Net Disposal Value (NDV), to better include the fair value of intangibles and hybrid instruments. NTA is the closest to the old NAV measure.]
Conclusions
Due to its structural advantages (resilience to macroeconomic downturns and some protection even in a pandemic due to a very strong balance sheet), Shaftesbury’s holdings are highly attractive to real-estate investors. The sell-off in its shares over the last few years is largely attributable to identifiable problems, all of which are likely to be temporary (yes, even Brexit: it is causing problems to a lot of UK businesses, but not to London prime real estate).
While macro headwinds (risk of reintroduction of restrictions, delays to recovery in international travel, inflation) and operational challenges (staff shortages, supply chain issues, cost pressures) persist, the outlook is positive, and there is huge investors’ appetite for real assets in the best locations.
Finally, there is always the possibility of a potential takeover by private equity/infrastructure funds (which have plenty of dry power to put to work) or a consolidation with Capco.
A successful takeover bid would have to be priced at a significant premium to the book value of Shaftesbury’s assets. While Capco bought its stake at a price of £5.4 in the middle of the pandemic, according to my calculation Norges Bank has an average cost base of ~£7.5, as it acquired most of its shares in 2017-2018 at prices above £9 (partly balanced by subscribing to the recent capital increase at £4). Despite the position being marginal within the huge Norwegian sovereign wealth fund, it is unlikely that a long-term investor like Norges would sell for less than £8 (or even just above).
SHB in merger talking with Capital & Counties, with SHB that would own 53% of the new entity
https://otp.tools.investis.com/clients/uk/shaftesbury1/rns1/regulatory-story.aspx?cid=520&newsid=1581051
SHB is out with the quarterly trading update:
https://otp.tools.investis.com/clients/uk/shaftesbury1/rns1/regulatory-story.aspx?cid=520&newsid=1548775
In summary:
- Short-term disruption to footfall from Omicron restrictions
- But demand is coming back and vacancies continue to decline (£11m new leases signed during the quarter)
- Almost 90% of rents collected in the quarter
- Two non-core properties disposed (for £11m), five acquired (for £18m) as opportunities arise in the core areas