Company Background
Elite Commercial Trust (ELITE) was listed on 6th Feb 2022. It specializes in commercial and real estate-related assets within the United Kingdom (UK). Its portfolio consists of 155 predominantly freehold commercial buildings located throughout the UK, with a combined valuation of £466.2mn as of Dec22. Over 99% of gross rental income originates from the UK Government, such as Department for Work and Pensions (DWP 93.2%), Ministry of Defense (2.4%) and National HM Courts and Tribunals Services (1.7%).
Key Investment Merits
We initiate coverage with a BUY rating and a target price of £0.36 based on DDM valuation, COE of 10.89%, and terminal growth of 1%. We expect DPU of £4.97 cents for FY23e and £5.5 cents for FY24e, translating into yields of 16.58% and 18.35%, respectively.
Revenue
Gross revenue
In 3Q23, DWP made up for 93.2% of the portfolio’s Gross Rental Income (GRI). The tenant enables strong consistent rental collection of ~100% a quarter in advance. A total of 139 assets within the portfolio are designed to benefit from the built-in rental eslcation tied to the CPI starting in Apr23. The estimated range for rental escalation across these assets is between 11.0% and 15.4%.
Dilapidation settlement
Dilapidation assessment for vacating assets refers to claim for damages by the landlord against the tenant’s cost of repair. As of 3Q23, ELITE had completed 9 dilapidation settlements and received £1.9mn settlement fee and £0.4mn of lease surrender premium in 2Q23 and £8mn dilapidation fee in 3Q23. The settlements for 3 assets are still in progress. Divestment can only proceed upon completion of dilapidation settlement. So, we anticipate the next divestment is likely to be one of the 4 properties (Crown House, Sidlaw House, Lindsay House Ladywell House, or Hilden House) as the dilapidation settlement has already been completed.
Tenant Profile
DWP’s social services remains essential for UK citizens, as they continue to provide support over 22mn claimants as of Feb22. As the largest public service department under the UK Government, it is responsible for important services such as welfare, pensions, and child maintenance, DWP disbursed a total of £217 billion in benefits and pensions during FY21/22. Around 85.5% of the assets within the REIT’s portfolio that are occupied by DWP serve as front- of-house facilities, primarily operating as front-facing Jobcentre Plus offices. The remaining 14.5% of assets serve as back-of-house support services, encompassing call centers, claims processing, finance, accounts, and investigation functions. DWP tends to expand during the economic downturns along with raising unemployment as as it plays an important role in boosting employment and in-work progression, as well as delivering vital support and services to people in need in society.
Revenue Growth
We expect 0.82% YoY revenue growth for FY23e, amounting to $37.38mn. The CPI-tied rental reversion of 13.1%, which took effect in April 2023, is expected to be partially offset by 12 vacant buildings and 11 rental reductions (c.30%), contributing to 2% of the FY22 income in the portfolio. Despite the current conservative economic outlook, we remain positive about the stable income stream provided by the major tenant, DWP, as there is no more break clause for further rental reduction or lease expiring until FY28.
Due to the low physical occupancy (an average of 50%) in the UK, 11 properties had reduced their rental, with 3 at 45% and 8 at 30%, contributing to a total of 2% revenue reduction. ELITE has been actively working on divesting the 8 vacant assets, which account for c.5% of the total rental income. The balance sheet has improved at the cost of eroding the topline. We continue to expect an improvement in sequential growth in 2H23, though we see risks from the depressing physical occupancy.
Expense
The operating expenses include, but are not limited to compliance with laws, regulations or policies, direct or indirect tax policies, laws or regulations, sub-contracted service costs, labour costs, and repair and maintenance costs.
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Miaomiao mainly covers the Singapore REITs sector and graduated from Singapore Management University with a Bachelor’s degree in Business Management.
