No. of Recommendations: 3
> "One thing to watch out for is the "institutional imperative"
I agree one must always watch out for this, and I've seen what you described happening in front of me at a previous employer.
> "to sell properties that they could realize at or very close to their IFRS carrying values, which would likely be the better ones with the better business futures"
In formal company announcements, Unite have made clear that the goal this year is to market the stuff that's troubled or complicates management or financial predictability e.g. non-core (such as random properties/landbank they picked up over the years).
For example:
----
https://www.investegate.co.uk/announcement/rns/uni..."£500 million of assets for disposal in the next 6-12 months (Unite share basis) - Advisers appointed to support acceleration of further asset disposals to reposition towards higher-quality portfolio aligned to the strongest universities"
----
https://markets.ft.com/data/announce/detail?dockey..."A further c.£500 million of assets on a Unite share basis are being actively marketed or prepared for sale, including lower-growth assets, non-PBSA properties, development land and planned disposals from Empiric, which we expect to transact over the next 6-12 months.
Our planned disposals include a portfolio of c.7,000 beds in exit cities and lower-growth locations for which we have seen strong initial interest from investors, reflecting the portfolio's affordable rents and capital values significantly below replacement cost."
"The portfolio has a lower level of occupancy, nomination agreements and operating margins than the wider portfolio and would enhance the income visibility and growth prospects of the retained estate."
----
I want to highlight in that last quote - they are marketing *lower* occupancy properties, *lower* nomination agreements, *lower* margin properties, *lower* visibility on future income, *lower* growth.
----
I feel that is very unambigious.
I mean, any management can claim they will do (A) but then rush off to do (B) instead, but here, there is a lot of logic that supports selling the worst parts of the portfolio.
Those parts are the most rational thing for a motivated buying team to pick up - you can't do a turnaround / redevelop an asset that's already performing at 100% occupancy in an expensive area. Also, they are the parts where the rental yield instantly exceeds the cost of debt, even on day 1, they're producing positive cashflow, you're not relying on stuff like growth or contractual reversion or future supply/demand or whatever.
I would agree with you that 90%+ of the time in investing, when a company's management *need* to flog something to raise funds quick, selling quality assets is easier and generally looks much better in terms of sale price/NAV in the resulting company news announcement - rather than selling 'junk'.
However, in this case,
a) Unite don't 'need' to sell anything
b) Unite get multiple wins by selling off 'junk' or 'hassle', even if it's at a cyclically low point to sell it.
- reduces management overhead costs & hassle i.e. 'the customers that take up 90% of your time'
- increases the predicability of the remaining portfolio via university block-booking for years ahead - visibility and low volatility in earnings helps with things like borrowing
- the 45% NAV discount absolutely overwhelms the cyclical pain of current book value on the sale.
- these properties were generally (relatively) cheaper to build to begin with, i.e. when constructed, the yield on cost was higher than usual, and likely the sale yield will be close to cost of construction
- it allows them to avoid renewing debt at current expensive levels.
What's happening is a clever financial hack - it pays for a buyer to pick up these properties and put the effort into turning them around or redeveloping into other property types; and it also pays for Unite NOT to branch out in that business direction themselves, but rather, stick with what they're actually good at, with stuff that makes the business run smoothly and cheaply for shareholders and creditors.
It's a situation where the sum of the parts is potentially greater than the whole.
It's the low share price relative to NAV that enables the 'hack' to work so beneficially for both parties; the buyer gets a bargain property to redevelop or run; and Unite get to buy extreme bargain shares with the proceeds, they get lower earnings volatility, they get less need to renew debt at prevailing rates, they get lower management overheads. Win/Win.
Ironically, if Unite's share price was still high, they'd be forced to work their ass off turning around these properties themselves, instead of using the 45% NAV discount hack.
> I think we all (management and potential investors both) should be aware of the risk that the target UK student population was in a bubble and may shrink a lot
You might as well be talking about the 'part of the UK population that eats out is in decline' when discussing a London restaurant. It doesn't matter what happens at the UK level. What matters to any business is what happens where the business operates. Dollar General in the USA is not impacted if people in Spain stop going to one-euro stores.
If you own a restaurant in London which is reliably packed every night, you can sleep well even if every restaurant in Aberdeen goes bust.
> Management make pleasant sounding noises about new PBSA units coming onto the market falling a lot
*Everyone* makes noises about the structural lack of PBSA. The shortage is extreme, and it's a problem of feast and famine geographically. Excessive opportunistic builds in the areas that granted PBSA building licenses willy-nilly, and hilariously inadequate PBSA build in the places with unquenchable need, but limited ability to build.
> total supply is high and still rising, and perhaps shouldn't be
The issue is that 'the market' is not 1 market, it is 3 markets, with totally different characteristics, geography and operators.
There are places like Cambridge, London etc where demand overwhelmingly outstrips supply. 99% occupancy.
There are places roughly in a balance of supply and demand. 95% occupancy.
There are places where supply overwhelmingly outstrips demand. 80-85% occupancy.
Looking at 'totals' is extremely misleading. Unite don't operate everywhere, in the past, now, or in the future.
The problem with UK PBSA isn't that there is simple over-supply or under-supply at a national level. The problem is that there's both at the same time varying by local geography, and no national norm at all.
It was easy & attractive to build in certain places, and difficult in others. So the easy places now have structural over-supply, and the other places have structural under-supply. Looking at totals or averages nationally, either for PBSA or student totals, completely misrepresents the economic reality of what is happening.
Separately, yes there is always a question (like with DG & dollar stores, or BLND/LAND with office property) of whether a long-term downturn may prove to be structural and everywhere when you thought it would be cyclical or regional; or whether a cyclical downturn continues so long that a structural one takes over from it.
TBH I think the real problem is not so much about supply/demand of people who would like to rent at universities (as far as most Unite locations are concerned). But rather that the customers are exhausted, there is simply no more money in the student wallets left to pay for higher and higher rents. That shows up in both occupancy and LFL rental growth even at the best university markets. It's a consequence of the great LFL growth of e.g. a few years ago at 8%/year.
The *magic* of traded REITs is that if investors mark down the REIT share price *excessively* because of this or any other problem, relative to the reality of that problem or risk - e.g. a 25%+ discount to a realistically achievable NAV - then REIT managers can flip assets and exploit the share price to manufacture hyper-growth for a few years.
The *dangers* (IMHO) are these:
- if the REIT has high debt near the limits of covenants etc, and is priced with a discount, it can't raise new capital without brutal dilution if it ever needs cash in a hurry (e.g. go update these buildings to comply with a new building code or you can't rent them at all!). In which case, the issue is not about e.g. hacking the market with asset flips and buybacks, the issue is immediate survival. This does not apply here.
- if the REIT is too small, then 'shrinking to arb the two markets' doesn't work, because many overheads are fixed, and the REIT becomes less efficient as properties are sold even if shares are bought back at a discount. And the worsening efficiency / cost ratio can overwhelm the NAV gain bonus. Thankfully, this does not apply here; in fact, the opposite, as the management's idea is to reduce business complexity and overheads.
- if the REIT is externally managed (e.g. an external private management company looks after a property portfolio for fees, and gets paid per the scale of the portfolio), the problem is that notoriously they will do anything to avoid shrinking the total portfolio size, regardless of what benefits the shareholders, since shrinking reduces their own pay. In fact, this issue is so big that a) externally managed REITs tend to trade at e.g. 10% discount to NAV simply from that factor alone, even at the best of times b) externally managed REITs largely went the way of the dodo in the USA because of this problem - they're just 3% of the USA REIT market nowadays - back in the 1980s, it was 100%. Thankfully, Unite is internally managed.
- as you said at the top - if a management team flips the best assets from urgent need to do so, and what's left continues to deteriorate, the growth-hack boost from discounted buybacks may be overwhelmed by broader structural decay in what's left.
- potentially, if a REIT sells off a ton of assets and the share price recovers too quickly (or if they dilly-dally with cash), they may not be able to deploy the money into buybacks in a way that generates a win, and they have the frictional drag of lots of loose cash in the portfolio (bad for metrics/business efficiency). They may even be tempted to do something foolish with it. Actually there's an example in the UK of a REIT that raised a ton of money by issuing stock, held it waiting for opportunities, then never invested it as the market soared away from them. Whoops.
Obviously, it would be nicer if this Unite situation was arising in an era when student numbers everywhere were going up regardless of geography or anything else, or if student willingness and ability to borrow loans was going higher and higher.
But if that was the case, you wouldn't get the discount occurring in the first place. You wouldn't be seeing the share price back at lows from 15 years ago or whatever.
As with all value investing I feel the trick is deciding when "it's a bit bad, but certainly not *that* bad" applies to the share price vs business value - and whether there's any mechanism for either management or shareholders to arbitrage that gap between perception and reality, whether that's by patience & time, or by direct mathematical mechanics.
With REITs, it's *proven* that flipping assets near NAV, against a chunky share price discount to NAV, can be a tremendous way for managers to arb stockmarket-perception against propertymarket-reality, to the benefit of shareholders (and themselves).
In short; being aware of broad economic and social issues is good *except* when the real issues are regional and local. Being aware of the tendency of managers to sell the family silver and keep the junk is always useful, but here, there is a wide range of compelling reasons for management to intentionally sell the junk and keep the silver - and the 45% discount to traded NAV combined with a cyclical low on the underlying assets is the key factor that makes it rational for everyone involved, both buyers and seller.
As always, merely my humble personal opinion, and please check any claims I make before relying upon them.
TRS
