22 Feb 2019

IRES REIT: Stronger than expected FY18 results

FY18 results have come in ahead of our expectations, with net operating income, EPRA EPS, DPS and NAV 3-5% better than what we were anticipating. A strong market backdrop; extensive pipeline of development and acquisition opportunities; operational excellence; and an attractive dividend are all bull points for what we view as the compelling IRES story.

IRES beat expectations on all key metrics. Net operating income was 3.0% ahead, helped by higher rents and good cost control. Operating leverage helped to produce a 4.7% EPRA EPS outperformance which, in turn, delivered a DPS of 5.6c, 4.8% higher than we were expecting. EPRA NAV climbed 20% last year to finish at 142c (3.9% above our forecast), helped by a 12.6% increase in the value of properties held throughout the year. The portfolio gross yield at fair value is 6.1% (end-2017: 6.5%), 20bps inside the national average. We believe that a well-invested (and managed), relatively young portfolio that is 100% located in Ireland’s main economic hub should trade further inside the national average.


The fundamentals of the Irish housing market remain supportive for IRES. Despite an ongoing increase in output, the most striking feature of the Irish residential property market remains a wide disparity between supply (18,072 completions in 2018) and demand (estimates of annual household formation run from 30,000 to 50,000). These dynamics helped to drive IRES’ end-2018 portfolio occupancy of 99.8% and LFL rent inflation of 3.6% (in-place Dublin rent growth is capped at 4.0% per annum).


While the FY18 dividend equates to a 3.7% yield, we expect to see meaningful medium-term growth in distributions as IRES leverages its strong balance sheet (gearing of 33.6% at end-2018) to pursue its own developments and forward purchase transactions (which should add c. 800 units in total versus an end-2018 ‘base’ of 2,679) over the coming years. For more detail on this, please see our note published this morning.


Irish Banks: No Consent, No Sale bill may have easier passage than expected


The Irish Times is this morning reporting that the controversial No Consent No Sale legislation being proposed by Sinn Fein in the Irish parliament may not need government approval (a so-called money message) in order to come into legislation. This would clear a significant hurdle in the bill’s passage to becoming law. The proposed legislation would require borrowers’ consent before a loan could be sold or transferred out of the originating bank involved in the loan to another institution.


Ostensibly the legislation would ensure that loans do not end up being transferred to so-called vulture funds who may deal with delinquent borrowers in a more abrasive manner than mainstream banks would generally approach an arrears case. This would make resolving non-performing loans more difficult in terms of limiting the ability of an originating institution to dispose of the loan in an expedited manner. However we are concerned about the potential for significant additional issues which the legislation would create, namely the use of residential mortgages as collateral in securitised structures and covered bond pools. The legislation, as currently reads, would effectively rule out the use of mortgages as collateral in the future, significantly limiting funding options for originating banks, whether through securitizations, covered bond sales or private market repo, but also including access to the various ECB liquidity windows. We believe this would increase the cost of funding for the Irish banks and the cost of borrowing for Irish consumers. We are further concerned that the proposed legislation would make some banking models (originate-and-securitise) almost inoperable, and make the Irish mortgage market much less attractive for any potential new entrant (particularly any entrant that did not have excess deposit funding already on hand).


We believe the legislation to be ill advised and potentially damaging to the Irish banking sector, likely delivering negative outcomes for both borrowers through higher lending rates and taxpayers through lower equity values for the stakes which the Irish government holds in the Irish banking sector.


Irish Homebuilders: Land at Clonburris SDZ comes to market


Savills has brought to market a significant plot of residential development land at Clonburris Strategic Development Zone (SDZ) in West Dublin. The site extends to 65 acres and could accommodate between 800 and 950 residential units (as well as some commercial space) according to the agents. It has a guide price of €27.5m which equates to a prospective cost per unit of €29k, based on the top of the range of potential units.


Although it has taken longer to come to fruition than initially envisaged, the SDZ at Clonburris is expected to be formally adopted this year (the process is currently at appeals stage and Oral Hearings were held by An Bord Pleanala last month). Local authorities can designate areas of economic and social importance as SDZs and the main advantage of building within such a zone is recourse to a streamlined planning process for developments that are consistent with the principles of the SDZ, although some of these advantages have been negated by the introduction of a separate Strategic Housing Development “fast-track” planning process for large residential schemes. Clonburris itself is approximately 13km west of Dublin city, close to the M50 orbital motorway and railway infrastructure and the SDZ is expected to ultimately deliver more than 8,000 residential units, eight schools and other community facilities.


Cairn Homes already owns a sizeable plot of land (178 acres) within the proposed Clonburris SDZ that it acquired as part of Project Clear in late 2015, which should be able to accommodate at least 3,000 units in due course. This land was acquired at a prospective cost of less than €20k per unit, highlighting the “hidden value” of its early land buys. Glenveagh is still active in the land market and we expect that it will be more likely to run the rule over this opportunity, if it has not done so already.


ECB account


Yesterday saw the ECB publish the account from its Governing Council (GC) meeting held on the 24 January.  In truth much of the account reiterated remarks made in President Draghi’s post decision press conference in January. In particular the ECB’s GC held the view that economic data had deteriorated and had been weaker than expected and given recent outturns the near term growth outlook was likely to be softer than previously expected. The ECB highlighted a number of factors undermining the growth backdrop - chief among those were trade tensions and the impact they were having on global growth. In particular the ECB made much of the impact on China and that Chinese imports at the end of 2018 had been much weaker than expected. Trade was not the only factor mentioned - Brexit was another, as well as country specific factors such as the auto sector. Whilst most of the economic slowdown had been attributed to trade, the ECB did note that in the recent quarters there had also been a slowing in private consumption and employment growth.


The key question for the ECB was whether the current soft patch was set to turn into something more pronounced. On this point the central view continued to be that the economy would rebound, underpinned by easy financial conditions, a solid labour market, easing trade tensions and as the negative influences from special factors began to fade. However the ECB was less certain over when such a rebound would take place, leaving the GC in a position of wait and see. On policy itself the accounts did reveal there were further discussions around the provision of longer-term liquidity provision. Here it was noted that technical analysis should be undertaken swiftly. Our overall conclusion would be that the accounts were on the slightly dovish side. However we would also note than the ECB meeting was four weeks ago and since then Governing Council members have in general sounded more dovish and that talk of a new TLTRO has increased. Of particular note yesterday were Austrian central bank governor Nowotny’s comments that the debate was “if ECB normalisation should continue”. As such the prospect of an ECB rate hike this year is diminishing.


Brexit news?


There do not appear to be too many surprises overnight. PM May’s visit to Brussels does not appear to have resulted in the sudden appearance of a ‘magic bullet’ and it looks very much as if next Wednesday’s parliamentary vote will not be directed towards a revised deal. Indeed even EU Commission President Jean-Claude Juncker remarked that he was suffering from ‘Brexit fatigue’ and that he was not optimistic that the UK would leave with a deal. Meanwhile amid more talk of a delay to Britain’s departure beyond 29 March, some ERG members are said to have threatened to vote against the government in any subsequent vote of no confidence. Mrs May will be meeting various EU leaders in a Summit held in Sharm El Sheikh over the weekend, but the significance of this has been played down by some observers.


Economic Releases


09.00 GE IFO Business Climate  

10.00 EU Consumer Price Index

11.00 UK CBI Retailing Reported Sales

13.30 CA Retail Sales