Final Results
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Custodian REIT plc (CREI)
17 June 2022
Custodian REIT plc
(“Custodian REIT” or “the Company”)
Final Results
Custodian REIT (LSE: CREI), the UK commercial real estate investment company, today reports its final results for the year ended 31 March 2022.
Property strategy
Custodian REIT offers investors the opportunity to access a diversified portfolio of UK commercial real estate providing an attractive level of income and the potential for capital growth, becoming the REIT of choice for private and institutional investors seeking high and stable dividends from well-diversified UK real estate. The Company’s portfolio is focused on smaller lots, principally targeting properties of less than £10m at acquisition, which offers:
Commenting on the final results, David Hunter, Chairman of Custodian REIT, said:
“The year to 31 March 2022 has been a period of significant recovery for the Company’s net asset value and share price after the extreme challenges presented by the global pandemic.
“The recovery in NAV has been testament to the strength of the UK commercial property, allied to Custodian REIT’s focus on smaller regional property and the close management of the portfolio to maximise occupancy, rent collection, cash flow and earnings.
“Rent collection is back at pre-pandemic levels and tenants have honoured their deferred rent agreements allowing the Board to increase fully covered quarterly dividends to at least 5.5p in the forthcoming financial year.
“Although the impact of inflation and political uncertainty could lead to an economic downturn, we believe Custodian REIT’s portfolio, diversified by sector, geography and tenants, with low gearing will remain resilient in the face of any economic headwinds.”
Alternative performance measures
The Company reports alternative performance measures (“APMs”) to assist stakeholders in assessing performance alongside the Company’s results on a statutory basis, set out above. APMs are among the key performance indicators used by the Board to assess the Company’s performance and are used by research analysts covering the Company. Certain other APMs may not be directly comparable with other companies’ adjusted measures, and APMs are not intended to be a substitute for, or superior to, any IFRS measures of performance. Supporting calculations for APMs and reconciliations between APMs and their IFRS equivalents are set out in Note 21.
Further information regarding the Company can be found at the Company's website www.custodianreit.com or please contact:
Property highlights
Investment Policy
The Company’s investment policy[16] is summarised below:
The Board reviews the Company’s investment objectives at least annually to ensure they remain appropriate to the market in which the Company operates and in the best interests of shareholders.
Richard Shepherd-Cross, Investment Manager, commented: "Our smaller-lot specialism has consistently delivered significantly higher yields without exposing shareholders to additional risk”.
The Board is committed to seeking further growth in the Company to increase the liquidity of its shares and reduce ongoing charges. Our growth strategy involves:
In all situations, the Board ensures that property fundamentals are central to all decisions.
Acquisition of DRUM Income Plus REIT plc
In November 2021 the Company acquired DRUM Income Plus REIT plc (“DRUM REIT”) at a 28% discount to its net asset value, resulting in a £7.3m valuation gain post-acquisition. Since acquisition DRUM REIT has traded well, enhancing the Company’s EPRA earnings per share and maintaining its ‘red-book’ valuation at £49m. Since the year end new lettings have been secured at certain sites which should further enhance total returns in the coming periods.
David Hunter, Chairman of Custodian REIT plc, commented: “Shareholders are seeking the consolidation of smaller REITs as larger funds typically offer lower operating costs with better liquidity. This acquisition demonstrated that the Company and its Investment Manager are capable of delivering accretive corporate acquisitions which benefit both existing and incoming shareholders.”
Diverse portfolio
Custodian Capital Limited (“the Investment Manager”) is appointed under an investment management agreement (“IMA”) to provide property management and administrative services to the Company. Richard Shepherd-Cross is Managing Director of the Investment Manager. Richard has over 25 years’ experience in commercial property, qualifying as a Chartered Surveyor in 1996 and until 2008 worked for JLL, latterly running its national portfolio investment team.
Richard established Custodian Capital Limited as the Property Fund Management subsidiary of Mattioli Woods plc and in 2014 was instrumental in the launch of Custodian REIT plc from Mattioli Woods’ syndicated property portfolio and its 1,200 investors. Following the successful IPO of the Company, Richard has overseen the growth of the Company to its current property portfolio of over £650m.
Richard is supported by the Investment Manager’s other key personnel: Ed Moore - Finance Director, Alex Nix - Assistant Investment Manager and Tom Donnachie – Portfolio Manager, along with a team of six other surveyors and four accountants. Chairman’s statement
The year to 31 March 2022 has been a period of significant recovery for the Company’s NAV and share price after the extreme challenges presented by the global pandemic. NAV total return for the year was 28.4%, up from 0.9% in the previous financial year due primarily to valuation increases of £94.0m during the year. Rent collection is back at pre-pandemic levels and tenants have honoured their deferred rent agreements which has taken recurring (EPRA) earnings to 5.9p per share.
Acknowledging the importance of income for shareholders I was delighted the Board was able to increase quarterly dividends during the year which took the total dividend declared for the year to 5.25p per share. This dividend was one of the highest fully covered dividends amongst its peer group of listed property investment companies[20] for the year ended 31 March 2022 and, in line with the Company’s policy, was 110% covered by EPRA earnings.
The Company is targeting a dividend per share of at least 5.5p per share for the year ending 31 March 2023.
Strategy for future growth
Custodian REIT supportively acknowledges the market desire for consolidation in the REIT sector, but inertia and entrenched interests can make delivering consolidation much harder than it should be. Despite these challenges we were delighted to announce the all-share acquisition of Drum Income Plus REIT in November 2021. Alignment of property strategy and a shared focus on income returns made a compelling rationale for the benefit of shareholders old and new.
The proposed closure of two large open-ended property funds by Aviva and Aegon and the anticipated sale of the entire £940m Janus Henderson UK property fund portfolio has marked a watershed for open-ended property funds offering theoretical daily dealing to retail investors. With universal recognition that the open-ended model has failed investors we see diversified property investment companies as the natural choice for retail investors and wealth managers seeking income from commercial property.
Shareholder income is derived from earnings and Custodian REIT operates with one of the highest earnings yields of its peer group giving it the greatest capacity to pay sustainable, fully covered dividends, which will make up the largest part of total return to shareholders. Based on most recently reported EPRA earnings Custodian REIT delivered an earnings yield[21], as at 31 March 2022 of 5.9%, versus a peer group average of 4.1%.
Net asset value
The NAV of the Company at 31 March 2022 was £527.6m, approximately 119.7p per share, an increase of 22.1p (22.6%) since 31 March 2021:
The net valuation increase of £94.0m saw significant increases in the industrial and logistics and retail warehouse sectors, comprising in aggregate 68% of the portfolio by value, which together have been the principal drivers of NAV growth through the year. Also of note has been the return to modest growth in the latter part of the year in our High Street portfolio, perhaps marking an inflection point in investor demand. Property valuation commentary is detailed in the Investment Manager’s report.
Custodian REIT’s investment strategy has stood the Company in good stead again this year. For the year to March 2022, NAV total return of 28.4% has outstripped total share price return of 17.0%, which the Board regards as vindication of the quality of the portfolio and dividend capacity that might support future share price growth.
During May and June 2022 all of the serving Non-Executive Directors acquired shares in the Company, reflecting the Board’s view that the Company’s current share price does not sufficiently reflect the true value of its net assets.
The market
Thematic investment continues to dominate fund raising and is polarising property investment demand and pricing. The weight of capital chasing the industrial and logistics sector and more recently retail warehousing has led to some significant yield compression[24] and has boosted capital value returns for investors in logistics specialists. While this yield compression has led to NAV growth for existing investors, the counterbalance is that income yields are being materially squeezed. Custodian REIT’s regional smaller property specialism, targeting the marginal income advantage from smaller lots which offer a higher rental yield for the same level of property and tenant risk, has never been of greater relative importance than in current market conditions.
With logistics property yields now by some distance at historical lows, investors are acutely sensitive to any hint of slowdown from operators such as Amazon. At a time of rising interest rates we simply do not believe that yield compression driven growth will continue in logistics property over the next two years. Without further yield compression, investors are relying on continuing high levels of rental growth to deliver returns, which again points to the fortunes of the operators. A reversal of returns from logistics property will quickly highlight the risks inherent in a single sector property strategy, and we believe would generate a re-focus on diversified strategies where managers can exploit mispricing in sub-sectors of the office and retail markets, while still enjoying rental growth from industrial, logistics and retail warehousing.
The Company targets smaller regional properties, typically below the value level sought by larger investment funds, which results in higher yields and more robust vacant possession values with better mitigation against binary tenant and geographical risk compared to investing in larger lots.
Since 2016 the Company’s upper target lot-size has been £10m but capital values have seen significant price inflation since then, particularly in the industrial and logistics sector. The Board therefore recommends that shareholders approve an increase in the upper target lot-size from £10m to £15m at the Company’s next Annual General Meeting (“AGM”) on 31 August 2022. While even £15m remains below the general level of institutional demand, assets larger than £10m will only be acquired where we can still achieve a beneficial yield margin relative to larger lots and the proposed change will offer the Investment Manager the flexibility to consider a wider range of opportunities that fit the Company’s investment policy.
The Board will also propose broadening its investment policy’s definition of refurbishment to include the redevelopment of existing holdings, to a maximum 10% of the Company’s gross assets, at the Company’s forthcoming AGM to provide flexibility to maximise shareholder returns from existing assets.
Borrowings
Since the year end the Company has arranged a £25m tranche of 10 year debt with Aviva Real Estate Investors (“Aviva”) at a fixed rate of interest of 4.10% per annum to refinance a £25m variable rate revolving credit facility with Royal Bank of Scotland (“RBS”), acquired via the DRUM REIT acquisition. This refinancing will mitigate interest rate risk and refinancing risk for shareholders and increase the proportion of the Company’s agreed debt facilities that are at fixed rates of interest from 61% to 74%. The refinancing maintains the significant accretive margin between the Company’s 3.2% weighted average cost of debt post-refinancing and property portfolio net initial yield of 5.7%.
Investment Manager
The performance of the Investment Manager is reviewed each year by the Management Engagement Committee (“MEC”). During the year the fees paid to the Investment Manager were £4.4m (2021: £3.8m) in respect of annual management, administrative and transaction fees. Further details of fees payable to the Investment Manager are set out in Note 18.
The Board is pleased with the performance of the Investment Manager, particularly completing the corporate acquisition of DRUM REIT and its continued successful asset management initiatives, detailed in the Investment Manager’s report and Asset management report respectively, which contributed significantly to increases in net asset value, portfolio value and income. The Board is satisfied that the Investment Manager’s performance remains aligned with the Company’s purpose, values and strategy.
Board succession
After eight years of service, Matthew Thorne has indicated his intention to retire as Non-Executive Director of the Company at the AGM on 31 August 2022, in line with its succession plan. The Board would like to thank Matthew for his significant contribution to the development of the Company since his appointment on IPO in 2014.
Responding to Matthew’s expected departure we are delighted to welcome Malcolm Cooper who joined the Board on 6 June 2022 and will offer a range of skills including the financial expertise to take on the role of Chair of the Audit and Risk Committee and maintain the Board’s property and governance experience. We look forward to the contribution Malcolm will make.
The Board is conscious of stakeholder focus on diversity and recognises the value and importance of diversity in the boardroom. No Directors are from a minority ethnic background but the Company’s Board contains two women which satisfied the gender diversity recommendations of the Hampton-Alexander Review for at least 33% female representation on FTSE350 company boards at the year end. As a constituent of the FTSESmallCap Index Custodian REIT is not bound by this recommendation. The Board supports the overall recommendations of the Hampton-Alexander and Parker Reviews for appropriate gender and ethnic diversity although it is not seen to be in the interests of the Company and its shareholders to set prescriptive diversity targets for the Board at this point.
The recruitment process involved the use of external consultants and focused on key skills a new Director would bring including financial experience as well as diversity of experience, background and approach as well as the traditional facets of gender, ethnicity and age.
Environmental, social and governance
The Board recognises that its decisions have an impact on the environment, people and communities. The Board also believes that the Company’s property strategy and ESG aspirations create a compelling rationale to make environmentally beneficial improvements to its property portfolio and incorporate ESG best practice into everything the Company does.
On 1 April 2021 the Board constituted an ESG Committee to: set and amend where necessary the Company’s environmental key performance indicators (“KPIs”) and monitor its performance against them; ensure it complies with its environmental reporting requirements and best practice; assess the engagement with the Company’s environmental consultants and assess the level of social outcomes being achieved for its stakeholders and the communities in which it operates.
The Company's ESG policy outlines our approach to managing ESG impacts and provides the framework for setting and reviewing environmental and social objectives to ensure we are continuously improving our performance and setting a leadership direction.
As a result, the Board has committed to:
Progress towards these commitments during the year, details of the Company’s environmental policy and performance against its targets are contained within the ESG Committee report within the Strategic report.
The Board is determined to ensure the Company’s pathway towards net zero carbon fits with stakeholder expectations and the Company’s property strategy. We see the careful implementation of a practical carbon reduction strategy as a crucial next step in the Company’s ESG journey and during the course of the year ending 31 March 2023 we will engage advisors to assist the Investment Manager in developing a detailed plan to achieve this.
Cladding
Custodian REIT’s portfolio has no exposure to ‘high risk’ assets which are typically either high-rise buildings (those over 18m tall) which use cladding in their construction or those used for multiple residential occupation. However, during the year the Board instigated a detailed review of the Company’s cladding risks and obligations involving the Investment Manager and the Company’s solicitors. This review has resulted in the Investment Manager implementing a more extensive cladding policy, moving beyond the mandatory fire risk assessment requirements for properties where the composition of cladding material is unknown and considering core-drilling and replacing, where necessary, cladding not compliant with Loss Prevention Certification Board guidelines.
Company name
To better reflect the Company’s focus on income and to facilitate retail investors more easily accessing the Company’s shares via online platforms, the Board will propose changing the Company’s name from Custodian REIT plc to Custodian Property Income REIT plc at the 31 August 2022 AGM.
Outlook
The Company enjoys the support of a wide range of shareholders with the majority classified as private client or discretionary wealth management investors. The Company’s investment and dividend strategy and diversified portfolio are well suited to investors looking for a close proxy to direct real estate investment but in a managed and liquid structure. Capital flows out of the failing open-ended property fund model and investors moving from a yield compression fuelled capital growth strategy to a long-term, secured income strategy will find their interests aligned with Custodian REIT.
Inflation is a clear and present risk in the market today. Traditionally investors have looked to real estate as a hedge against the negative impact of inflation on investment returns as over the longer term historically property values and rents increase in an inflationary environment. Following a period of growth, the challenge for real estate companies is to own properties with further rental growth potential whose valuation will most closely keep pace with rising prices; Custodian REIT’s approach to this challenge is expanded upon in the Investment Manager’s report.
The impact of inflation, particularly in energy and food prices, on consumer spending, supply chain constraints and the uncertainty caused by the war in Ukraine and the aftermath of the COVID-19 pandemic could lead to an economic downturn but we believe Custodian REIT’s portfolio, diversified by sector, geography and tenants, with low gearing will remain resilient in the face of any economic headwinds.
Income is likely to form the greater component of total return over the next phase of the property market and we believe that Custodian REIT’s strong income yielding portfolio, supported by higher-than-peer group EPRA earnings per share, will underpin shareholder returns.
David Hunter Chairman 16 June 2022 Investment Manager’s report
The UK property market
Market sentiment remains strongly positive for the industrial and logistics sector. Positivity has emerged, post COVID-19 lockdowns, for central London and major regional city offices and the retail warehouse sector has challenged the general retail malaise. As we have reported over the last six months there is a nascent recovery in sentiment towards high street retail, but only in prime pitches and in leading retail centres. So, with the exception of secondary retail, business park offices and secondary leisure schemes, market demand is driving value increases across the board which has led directly to seven consecutive quarters of NAV growth for Custodian REIT.
Sector by sector the Custodian REIT portfolio has followed the wider market trends during the year with, like for like, the industrial and logistics valuation increasing by 26.4%, retail warehousing increasing 16.4% and high street, although decreasing by 4.8% in the year, bottoming out and showing a 7.3% increase over the last six months. The office portfolio showed a slight like-for-like increase in value of 1.9% reflecting the 50% weighting to business park offices, which have been a slight drag on performance. Prime regional city centre offices have fared better post COVID-19 lockdowns. The current strategy is to weight our office allocation away from business parks and towards strong city centres, as recent acquisitions in Manchester and Oxford have demonstrated, where we are witnessing the strongest occupier and investor demand and we believe the office portfolio is set fair to see growth.
There is rightly a keen focus on inflation at present and whether real estate investment can offer a degree of inflation hedging. In short, the answer must be ‘yes’ as rents should grow over time, but with typically five-yearly rent reviews and average unexpired lease terms of circa five years, investors should not expect a straight-line relationship between rents and inflation. Much focus is currently on RPI and CPI linked rent reviews, generally capped at up to 4% per annum, which of course provide shorter-term comfort but can have the effect of creating bond like investment characteristics with a greater emphasis placed on tenant covenant than the property fundamentals. At some point in a property’s life cycle rents will always be re-based to open market values. An over-reliance on index linked rent reviews can lead to disparity between investment values and underlying property values. Over the long term we do not feel indexed rent reviews are a worthy substitute for owning good real estate where we back open market rent reviews to deliver rental growth. For long-term investors, such as Custodian REIT, the aim is to provide inflation protection from the bricks and mortar, not from the contractual terms of the leases.
Across the industrial and logistics portfolio, notwithstanding the rental growth to date, the average rent stands at only £6.17 per sq ft for let properties (£5.27 including vacancies) with an estimated rental value of £7.05 per sq ft (£6.20 including vacancies), suggesting a latent rental uplift of c.14%. Furthermore, both passing rents and estimated rental values are some way below the rent required to bring forward new development, indicating further growth potential.
Retail warehousing and high street retail rents appear to have bottomed out and we are seeing some recent demand led rental growth in these sectors. Importantly retail rents are growing from a low base, following a period of rental decline making them affordable for tenants. By way of example, the average retail warehouse rent across the portfolio stands at circa £14.30 per sq ft (£13.58 including vacancies), broadly in line with current estimated rental values and much lower than average market levels.
In select locations, notably prime regional city centres, we are seeing office rents increasing. This is by no means applicable to all regional offices but is focused on high quality, flexible office space with strong environmental credentials. The recent acquisition of 60 Fountain Street in Manchester is an example of how Custodian REIT is taking advantage of the opportunity to reposition property to meet the expected demands of tenants, post pandemic, and to pick up the higher rents attributable to refurbished space.
The greater driver of inflation appears to be cost-push rather than demand-pull as the economy struggles with supply chain constraints, energy price increases, labour shortages and the aftermath of pandemic restrictions. These factors all mitigate against widespread, low cost, speculative development which would otherwise help resolve the demand/supply imbalance that is promoting rental growth.
We believe Custodian REIT’s portfolio is particularly well positioned to see rental growth as it is focused on smaller regional properties:
In the industrial and logistics sector, which accounts for 49% of the portfolio by value, smaller properties are more expensive to develop, pro-rata, so require higher rents to justify development. Rents will continue to grow until they balance out inflation in build costs.
The retail warehouse portfolio is almost exclusively focused on DIY, homewares, discounters and food, all let off affordable rents. This occupier profile is best matched with current market demand and so well placed to pick up rental growth.
We have reorganised our high street retail portfolio over the last two years, exiting most of the secondary retail locations. We have let three vacant high street properties during the year and have terms agreed or are seeing active demand for the very limited remaining vacant space we have in the high street portfolio from both retail and leisure occupiers. Low vacancy rates in prime locations and occupier demand should be supportive of future rental growth.
In the office portfolio we have identified, or are progressing, a number of refurbishment opportunities with a keen eye on environmental improvements. Owners of smaller regional offices are often not sufficiently well resourced to create high quality small suite offices that are a match for the larger floorplates. However, we believe that occupier demand will be focused on higher quality space to support businesses in attracting their employees back into the office. We believe that by positioning our office portfolio to meet occupier demand we will reduce vacancy and drive rental growth.
Prevailing investment approach
Based on our assessment of the current market, our strategy of a regionally focused diversified portfolio, set out below, has proven resilient and we expect to continue to reinvest the proceeds from selective disposals.
Sectoral view
Industrial and logistics
The industrial and logistics sector has been flooded with capital, much of it overseas private equity, which has been a big driver of price inflation. The fundamental occupational dynamics for smaller industrial and logistics assets continue to support rental growth: increased demand from the logistics sector servicing ‘E-tailing’ and the onshoring of the national supply chain; lack of supply of modern, fit-for-purpose units and build cost inflation which is setting higher threshold rents to fund development. All of this has led to valuation growth which has been strongly positive for Custodian REIT. Vacancy rates are very low, against long-term averages, supporting cash flow and opportunities to invest at prices that are fully supported by vacant possession values still exist amongst smaller regional properties. Recently there have been indications that occupational demand for large distribution sheds may be decreasing, with Amazon suggesting it potentially has over-capacity, but the favourable dynamics of smaller lot-sizes which have seen less recent speculative development and are less reliant on the large retailers should make the Company’s portfolio defensive.
In summary:
High street retail
The high street retail sector is starting to find its feet after a difficult four years. The pandemic cleared out the last of the ‘lame ducks’ on the high street, so most retailers who are still trading appear robust and want to be in physical stores. In prime locations rents appear to be bottoming out, or even seeing a slight re-bound. Lower rents are supporting occupier demand and reducing vacancy rates and void periods, in prime locations, which is providing a degree of confidence to investors not seen for some time. The Company’s high street retail portfolio is, by and large, concentrated on retailers of essentials such as groceries, pharmaceuticals, banking and discount items rather than luxury or fashion items. This focus on ‘need’ versus ‘want’ retailers should prove more defensive as consumer spending capacity decreases in the current inflationary environment.
In summary:
Retail warehouse
Out-of-town retail has seen a quick turnaround in investor demand over the last 24 months, most particularly in the last 12 months. The combination of convenience, lower costs per square foot and the complementary offer to online retail has kept these assets trading strongly most notably amongst DIY, discounters, homewares and food retailers, which should prove defensive if consumer spending levels decrease. As the second largest sector in the Custodian REIT portfolio, the recovery in market sentiment towards out-of-town retail has been positive and vacancy rates remain low.
In summary:
Offices
The office sector is likely to be forever changed following the mass working from home experiment of the pandemic despite the government’s current drive to encourage a return to the office and the uncertainty a potential economic downturn brings. In truth, the change that this has brought about has been an acceleration of a trend that was already embedded. Prime, regional city centres appear to be showing demand from occupiers and investors alike and have outperformed business park offices. A clear trend that has emerged is the need for landlords to provide a greater level of service and flexibility to office tenants, the so called ‘hotelisation’ of offices.
The ‘hotelisation’ of offices
We expect a ‘hotelisation’ of office buildings to be necessary to entice employees away from their home office while driving rents higher.
The COVID-19 pandemic led many to call the demise of the office and valuations plummeted as employees set up work at kitchen tables across the country, but we do not believe that offices will become redundant and in ‘the eye of the pandemic’ Custodian REIT acquired offices in Manchester and Oxford and is using the former as a trial run for the next phase of office investing: ‘the hotelisation of offices’.
The Company is not quite breaking new ground but we are at the vanguard of other landlords with akin to a concierge service for office occupants, giving flexibility and services that are not typical in standard 25-year leases. While the concept is yet to be proven we know that tenants want more from their landlords than just a lease.
From conversations we are having with occupants and being occupants ourselves as a business, we know that there is nothing tenants hate more than looking at offices and being shown floor after floor of empty space with grey carpets. They don’t want to take a five-year lease, have to fit the space out and install a broadband connection; they don’t have interest in it, they don’t have time, or the resources to do it. On top of those costs, tenants then pay dilapidation costs to the landlord when they leave and must return the building to the state it was in when they took it.
What you are asking tenants to do is fit out an office, then strip it out, and put it all in a skip and that is not good for their ESG credentials.
Instead, we plan to offer tenants a ‘turnkey’ office with all facilities, fit out, and services managed by the Investment Manager. Occupants want a space they can walk into and most businesses need the same thing; a large meeting room, a small meeting room, a breakout area, a kitchen, a comfortable reception, desks with an internet connection as most people work from laptops, and there will be an element of hotdesking. Companies expect a flexible workspace where they will have three days a week heavy use.
Overall, we are seeking to invest in making the offices ‘nicer than being at home’ so people actually want to work there.
We are trialling the concept with the building in Manchester, and this includes converting the top floor into a covered roof terrace with a coffee lounge, additional meeting rooms for tenants to use and a yoga studio. Having spoken to tenants, we are confident they will pay more for a space that they can just walk into and start operating from. Most say they are willing to pay more to take all the hassle away and this will minimise vacancies and drive the rents higher, but we will be selective over appropriate locations for this format and will ensure upgrades are properly costed to ensure estimated costs are supported by expected rental and valuation increases.
This is just consumer behaviour playing out. People don’t buy cars anymore, they lease them with a service plan because that takes the problem away. You lease your phone and when the battery starts to die, you trade it in for a new one.
People are demanding a higher level of service but they do not want the same level of responsibility and ownership as 20 years ago.
Other
Our key sub-sector for growth within the alternative sector is drive-through where we have grown our holding to eight assets through acquisition, development or conversion of existing restaurant sites, with a further conversion and acquisition in the pipeline. We believe these assets offer significant rental growth potential and the conversions carried out during the year were subject to fierce occupier competition from established operators and, in particular, new entrants into the UK market from North America.
ESG
The sustainability credentials of both the building and the location will be evermore important for occupiers and investors. As Investment Manager we are absolutely committed to the Company’s challenging goals in relation to ESG and believe the real estate sector should be a leader in this field.
ESG has become an imperative for many investors. Commercial real estate is a significant contributor to national emissions so we believe an emphasis on how we can improve the “E” (Environmental) is particularly relevant for real estate. In this regard we are striving to beat the Company’s target to improve the Energy Performance Certificates (“EPC”) of the portfolio. During the year the Company has updated EPCs at 20 units across 15 properties covering 358k sq ft for properties where existing EPCs had expired or where works had been completed. For updated EPCs, there was an aggregate decrease in rating of 34 energy performance asset rating points.
Energy performance and emissions are important considerations across all redevelopments and refurbishments in the portfolio as is the importance of “S” (Social) in creating an engaging, appropriate and sustainable (in all senses of the word) built environment. We believe that ESG improvements are an opportunity for shareholders to benefit from the enhanced rents, valuations and ‘lettablilty’ of the portfolio which should deliver valuation improvements over and above the cost of the investment. Investing in real estate that meets the ESG requirements of occupiers and legislation should lead to shorter periods of vacancy, higher rents and enhanced values. Remembering the “G” (Governance) we have policies, embedded in our strategy, to keep Custodian REIT on target to meet the required standards but we remain focused on delivering returns at the same time. The targets the Company has set itself are set out in the ESG Committee report.
Property portfolio balance
The property portfolio is split between the main commercial property sectors in line with the Company’s objective to maintain a suitably balanced investment portfolio. The Company has a relatively low exposure to office and high street retail combined with a relatively high exposure to industrial and to alternative sectors, often referred to as ‘other’ in property market analysis. The current sector weightings are:
For details of all properties in the portfolio please see custodianreit.com/property/portfolio.
Acquisitions
The Company invested £63.5m in the following asset acquisitions during the year:
On 3 November 2021 the Company acquired 100% of the ordinary share capital of DRUM Income Plus REIT plc. Consideration for the acquisition of 20,247,040 new ordinary shares in the Company was calculated on an ‘adjusted NAV-for-NAV basis’, with each company’s 30 June 2021 NAV being adjusted for respective acquisition costs with DRUM REIT’s property portfolio valuation adjusted to the agreed purchase price of £43.5m (31 March 2022 valuation: £49.0m).
DRUM REIT’s property portfolio at 31 March 2022 is summarised below:
DRUM REIT’s portfolio represents an excellent fit with Custodian REIT’s investment policy, targeting smaller regional property with a strong income focus. The purchase price reflected a sufficient discount to DRUM REIT’s NAV to be accretive to existing Custodian REIT shareholders and to provide DRUM REIT shareholders with an increase in like for like share price, as well as delivering them a growing dividend from a much larger specialist in the smaller regional property sector with much improved liquidity.
Details of each property within DRUM REIT’s portfolio are:
Since the year end the Company has acquired:
Disposals
Owning the right properties at the right time is a key element of effective property portfolio management, which necessarily involves periodically selling properties to balance the property portfolio. Identifying opportunities to dispose of assets which the market overrates, have a special purchaser or that no longer fit within the Company’s investment strategy is important and through the year sales proceeds of £54.4m were £9.6m ahead of valuation when the disposals were agreed (or £5.4m above final quarterly valuations prior to sale).
Taking advantage of the strength and depth of demand in the industrial/logistics sector and the increasing demand from owner occupiers, we were delighted to conclude some opportunistic sales during the year. We concluded the portfolio sale of seven industrial units which we felt did not meet our medium-term aspirations for rental growth or might require a level of capital expenditure that we would not recover in the valuation. As part of the sale, we agreed a delayed completion which enabled us to partially reinvest the expected proceeds in advance of completion, which has helped to reduce cash drag.
We also sold, to owner occupiers/special purchasers, a B&Q retail warehouse in Galashiels and two car show rooms, in Stockport and Stafford as detailed in the complete list for the year below:
Since the year end the Company has sold a 25k sq ft car showroom occupied by Audi for £5.6m.
Outlook
The recovery in NAV during the year has been testament to the strength of the UK commercial property, allied to Custodian REIT’s focus on smaller regional property and the close management of the portfolio to maximise occupancy, rent collection, cash flow and earnings.
The absolute focus on income is central to the management style and strategy of Custodian REIT. This approach is likely to be validated as yield compression slows and shareholder returns are reliant on earnings and dividends. Rent collection has normalised and Custodian REIT has latent rental growth which will justify current valuations.
While thematic investment has been the overwhelming focus of investment over the last 12 months, we believe the diversified strategy, if applied with discretion and clear aims, will be able to capitalise on market mispricing for recovering sectors and offer shareholders a balanced and attractive risk adjusted return.
Richard Shepherd-Cross for and on behalf of Custodian Capital Limited Investment Manager 16 June 2022
Asset management report
Asset management strategy
Our asset management strategy is summarised as follows:
Our continued focus on asset management during the year including rent reviews, new lettings, lease extensions and the retention of tenants beyond their contractual break clauses resulted in a £13.4m valuation increase in the year.
Property portfolio summary
Key asset management initiatives completed during the year include:
These positive asset management outcomes have been partially offset by the impact of the Administrations of JTF Wholesale (£586k of annual rent) and Rapid Vehicle Repair (£71k of annual rent) which have resulted in an aggregate 1.8% decrease in the annual rent roll.
Letting activity is strong across most sectors. We have a strong pipeline of potential new tenants and since the year end have completed:
Occupancy has been negatively impacted by the acquisition of DRUM REIT but we expect levels across the portfolio, including DRUM REIT assets, to continue to recover over the next 6-12 months as we complete more new lettings, unless there were to be further significant tenant failures.
Property portfolio risk
We have managed the property portfolio’s income expiry profile through successful asset management activities with 57% of aggregate income expiring within five years from 31 March 2022 (2021: 53%). Short-term income at risk is a relatively low proportion of the property portfolio’s income, with 38% expiring in the next three years (2021: 31%) and our experience suggests that even in the current uncertain climate, the majority of tenants do not exit at break or expiry.
Outlook
Looking forward, we maintain a positive outlook with many of the asset management initiatives currently under way expected to come to fruition over the next 6-12 months which should see new tenants secured, leases extended and new investment into existing assets improving their environmental credentials and realising their full potential.
Alex Nix Assistant Investment Manager for and on behalf of Custodian Capital Limited Investment Manager 16 June 2022
ESG Committee report
The ESG Committee (“the Committee”) was constituted on 1 April 2021. Its key responsibilities are:
The Company is committed to delivering its strategic objectives in an ethical and responsible manner and meeting its corporate responsibilities towards society, human rights and the environment. The Board acknowledges its responsibility to society is broader than simply generating financial returns for shareholders. The Company’s approach to ESG matters addresses the importance of these issues in the day-to-day running of the business, as detailed below.
ESG approach
Environmental - we want our properties to minimise their impact on the local and wider environment. The Investment Manager carefully considers the environmental performance of our properties, both before we acquire them, as well as during our period of ownership. Sites are visited on a regular basis by the Investment Manager and any obvious environmental issues are reported.
Social - Custodian REIT strives to manage and develop buildings which are safe, comfortable and high-quality spaces. As such, our aim is that the safety and well-being of occupants of our buildings is maximised.
Governance - high standards of corporate governance and disclosure are essential to ensuring the effective operation of the Company and instilling confidence amongst our stakeholders. We aim to continually improve our levels of governance and disclosure to achieve industry best practice.
The Committee encourages the Investment Manager to act responsibly in the areas it can influence as a landlord, for example by working with tenants to improve the environmental performance of the Company’s properties and minimise their impact on climate change. The Committee believes that following this strategy will ultimately be to the benefit of shareholders through enhanced rent and asset values.
The Company’s environmental policy commits the Company to:
Cladding
Custodian REIT’s portfolio currently has no exposure to ‘high risk’ assets which are typically either high-rise buildings (characteristically those over 18m tall) which use cladding in their construction or those used for multiple residential occupation. Custodian REIT does have exposure properties where cladding material has been used in their construction, and where the composition of the material is unknown. During the year the Board instigated a detailed review of the Company’s cladding risks and obligations involving the Investment Manager and the Company’s solicitors. This review has resulted in the Investment Manager implementing a more extensive cladding policy, moving beyond the mandatory fire risk assessment requirements for properties where the composition of cladding material is unknown and actively core-drilling and replacing, where necessary, cladding not compliant with Loss Prevention Certification Board guidelines. This improved policy demonstrates that the Company’s commitment to community safety significantly exceeds the minimum required in discharging its duty as a ‘Responsible Person’[30]. A summary of the revised policy is set out below:
Environmental key performance indicators
During the prior financial year the Company set environmental targets measured by key performance indicators (“KPIs”) which provide a strategic way to assess its success towards achieving its environmental objectives and ensure the Investment Manager has embedded key ESG principles. These environmental KPIs cover our main areas of environmental impact including energy efficiency, greenhouse gas emissions, water, waste and tenant engagement.
These environmental KPIs also directly support climate risk mitigation and capture some ESG opportunities from the transition to a low-carbon economy. As we progress our climate-related risk identification and management, we aim to identify and implement further climate-related metrics that can more clearly define the impact of climate-related risks and opportunities on our business. ESG reporting frameworks, including GRESB, require businesses to disclose the KPIs which contribute towards benchmark scoring and potentially influence investor decisions.
The Company’s environmental KPIs in place during the year, and comments relating to our performance against each one, are set out below:
To help the assessment of progress against KPIs a central data management system, hosted by the Company’s environment consultants, has been established to provide a robust data collation and validation process. This data management system is being used to identify tenant engagement and asset optimisation opportunities and facilitates the communication of environmental performance data to various stakeholders.
Due to the success of the Investment Manager in meeting certain of the environmental targets during the year and the Board’s ambition to strengthen the Company’s environmental credentials, the Board has set the following revised targets to be reported against in the financial year ending 31 March 2023:
Investment decisions
Investment decisions will play a key role in achieving the Company’s environmental KPIs. The Company undertakes an environmental assessment on vacated assets and during the acquisition due diligence process, rating assets or tenants against a number of ESG factors which form part of the Investment Committee decision making process. This process also helps the Investment Manager evaluate the potential environmental risks and opportunities associated with an asset and the impact on the achievement of the KPIs.
The Company’s procurement policy for property services includes an assessment of new suppliers on their specification and use of sustainable and energy efficient materials, systems, equipment, onsite operating practices and performance evaluation/incentives put in place for direct external suppliers and/or service providers to employ sustainable processes in day-to-day work.
ESG policy
To achieve the Company’s environmental objectives and targets, the Investment Manager seeks to achieve the following:
Environment
Climate change adaptation & resilience
Energy consumption & management
Building materials
Greenhouse gas (“GHG”) emissions and management
Further information on our GHG emissions is set out within our SECR disclosures in the Directors’ report.
Waste management
Water consumption and management
On-site carbon-reducing technology
Biodiversity
Asset level safety, health and well-being
We wish to manage and develop buildings which are safe, comfortable and high-quality spaces. As such, our aim is that the safety and well-being of the occupants of our buildings is maximised. We will implement a property portfolio approach to well-being which encourages engagement with tenants, promotes carbon reducing behaviours, ensures maximum building safety and optimises the comfort and quality of occupancy.
Stakeholder engagement
We engage regularly with the following internal and external stakeholders on environmental and social matters:
To monitor energy consumption across the property portfolio, as well as identify opportunities to make energy reductions, the Company has engaged with Carbon Intelligence to provide strategic advice on the process. This collaboration promotes the ethos of investing responsibly and has ensured statutory compliance with the Energy Savings Opportunity Scheme (ESOS) Regulations 2014 and The Companies (Director’s report) and Limited Liability Partnerships (Energy and Carbon Report) Regulations 2018, and has facilitated inclusion of EPRA Sustainability Best Practice Recommendations in the Annual Report.
Case study – Redditch
The Company expects to receive planning permission in June 2022 to redevelop an existing 59,000 sq ft industrial building constructed in the 1980’s into a brand new 60,000 sq ft industrial/distribution facility.
The new development will be built with exceptional ESG compliance and will be certified BREEAM ‘Excellent’ as well as having an Energy Performance rating ‘A’.
In order to achieve this the specification will include: a carbon neutral base build, electric vehicle charging points, solar photovoltaic panels to the south facing roof elevations, LED lighting to warehouse and offices, cycle storage and shower facilities and bat roost to cater for local biodiversity.
The expected cost of the redevelopment is £5.8m and will generate an estimated rental value in the region of £500k pa. Given the occupation demand in this locality, we are confident the property will be pre-let prior to completion of the construction.
Case study – EV chargers
Our latest round of electric vehicle (“EV”) charger installations has resulted in the Company partnering with Pod Point, one of the largest national charging networks, to install EV charging points at our remaining retail warehousing sites and commencing the rollout across appropriate industrial and office sites.
At each retail warehousing site Pod Point identifies the optimum number of chargers to:
Installing EV chargers for public use also enhances properties’ occupier appeal by increasing both customer footfall and dwell time.
Office and industrial tenants now expect EV charging as a feature on-site when looking for properties based on their requirements for their EV/hybrid fleet or staff use. Pod Point provides advice on the required load management system, groundworks, and infrastructure to suit tenants’ requirements which are typically willing to pay a rental premium which allows the Company to at least re-coup its capital expenditure whilst meeting our ESG targets and future-proofing the asset.
We currently have 14 properties in the pipeline for installation with a total of 14 rapid (75kW) chargers at retail warehousing sites and a further 23 fast (7kW) chargers at office and industrial locations.
With many towns in the UK introducing clean air zones where a congestion fee is charged for driving through certain areas and the Government banning production of all new petrol or diesel vehicles from 2030, we expect to receive further demand and income for these chargers in the coming years.
Case study – charitable lettings
During the year the Company has allowed the following charitable lettings at some of its vacant retail space, rent free, which has saved the Company vacant rates and helped the communities in which it operates:
EPC ratings
During the year the Company has updated EPCs at 20 units across 15 properties covering 358k sq ft for properties where existing EPCs had expired or where works had been completed. For updated EPCs, there was an aggregate decrease in rating of 34 ‘energy performance asset rating points[35]
The Investment Manager is currently reviewing and undertaking new assessments of any EPCs that are older than five years and below a ‘C’ rating. A ‘C’ rating is expected to become the minimum standard under the Minimum Energy Efficiency Standard (“MEES”) in 2027.
The Company has the following ESG initiatives planned in the coming financial year:
The Company’s weighted average EPC score by rating is shown below:
The majority ‘E’ rated assets are within the office sector, including a number of assets from the DRUM REIT acquisition, and appropriate investment is planned to make the necessary improvements in these assets.
Climate-related risks and opportunities
Climate change poses a number of physical risks to our property portfolio, for example those caused by the increased frequency and severity of extreme weather events. The Committee also recognises there are a number of transition-related risks, including economic, technology or regulatory challenges related to moving to a greener economy which it needs to consider. But climate change also provides opportunities to invest in alternative asset classes or to provide tenants with additional services.
Governance
The Board is ultimately responsible to stakeholders for the Company’s activities and for oversight of our climate-related risks and opportunities. Specifically, the ESG Committee is the Board-level governance body responsible for reviewing our identified climate-related risks alongside our ESG strategy.
The Investment Manager maintains the Company’s risk management framework and risk register, which means our ESG objectives are embedded into the way the Company conducts and manages the business and the property portfolio day to day.
Risk management
During the year the Committee has revisited its climate-related risks and opportunities to determine continued relevancy and impact on the Company. With the external consultant, the Committee assessed the completeness and effectiveness of current controls and processes in place to mitigate and manage risks and opportunities. The Committee deemed all mitigation controls in place to be effective however a number of continuous improvement areas were determined which are highlighted in the table below as next steps which will be addressed and actioned via the ESG Committee. The Company’s ESG targets also support continuous monitoring of progress against the ESG strategy, capturing of opportunities and the mitigation of climate risks. These targets are reported against on a quarterly basis to the Committee by the Investment Manager and the Company’s environmental consultants.
To account for the long-term nature of climate change three time horizons were used within the assessment:
This period differs from the longer-term viability assessment of three years, as the outputs of our climate-related materiality assessment will be reviewed and built upon over time in order to effectively embed identified risks into our risk management framework.
Net zero[36] carbon pathway
Starting the journey towards net zero carbon is a crucial next step in our ESG strategy and making this journey fit with stakeholder goals and the Company’s property strategy is one of the key challenges facing the Company and the real estate sector. Developing a net zero carbon pathway, and choosing the right level of consultancy to support the Investment Manager in achieving this, is squarely on the Committee’s agenda for the forthcoming year.
Outlook
The Company will work towards achieving its refined ESG targets over the course of the next financial year, improving our understanding of the specific impacts of climate change on the Company, seeking to influence tenant behaviour to improve environmental outcomes and assessing our strategy towards creating a Net Zero pathway.
Approval
This report was approved by the Committee and signed on its behalf by:
Hazel Adam Chair of the ESG Committee 16 June 2022
Financial review
The Company has enjoyed its strongest year of total return as the market continued its recovery from the impact of the COVID-19 pandemic, with a profit before tax of £122.3m (2021: £3.7m) and EPRA earnings per share of 5.9p (2021: 5.6p). The Company’s rent collection level has stabilised to pre-pandemic levels which has supported the Board increasing dividends per share declared for the year to 5.25p (2021: 5.0p), 110% covered by EPRA earnings.
A summary of the Company’s financial performance for the year is shown below:
The Company’s rent roll has increased by 4.7% from £38,692k at 31 March 2021 to £40,493k at 31 March 2022, which resulted in IFRS revenue increasing from £39,578k to £39,891k.
This increase in contractual rent was due primarily to net property acquisitions, but importantly also from aggregate rental growth across the portfolio and the positive impact of asset management activity in increasing like-for-like occupancy through net new lettings, which demonstrate the robust nature of the Company’s diverse property portfolio.
EPRA earnings per share increased to 5.9p (2021: 5.6p) due primarily to the stabilisation of rent collection rates, with a £0.3m decrease in the doubtful debt provision during the year comparing to a £2.7m increase in the prior financial year; partially offset by the timing of acquisitions and disposals and increased professional fees from more regear and new letting activity.
Dividends
The Board acknowledges the importance of income for shareholders and during the year its objective was to pay dividends on a sustainable basis at a rate fully covered by net rental receipts which does not inhibit the flexibility of the Company’s investment strategy.
The Company paid dividends totalling 5.625p per share during the year (£24.2m) comprising fourth and fifth interim dividends relating to the year ended 31 March 2021 of 1.25p and 0.5p per share respectively, and quarterly interim dividends of 1.25p, 1.25p and 1.375p per share relating to the year ended 31 March 2022.
The Company paid a fourth quarterly interim dividend of 1.375p per share for the quarter ended 31 March 2022 on 31 May 2022 totalling £6.1m. Dividends relating to the year ended 31 March 2022 of 5.25p (2021: 5.0p) were 110% covered by net recurring income of £25.3m, as calculated in Note 21.
Cost control
The Company’s tiered management fee structure, detailed in Note 18, meant that marginal investment management and administration fees decreased during the year as NAV increased to above the £500m hurdle. However, the Company has continued to invest in its environmental and governance structures and has also increased its marketing budget which has resulted in the OCR (excluding direct property costs) increasing from 1.12% for the year to 1.20%. Although governance related expenditure is likely to continue to increase we believe the economies of scale provided by the Company’s relatively fixed cost base and fee structure will mean that further growth will allow ongoing charges to be kept proportionately low.
Key performance indicators
The Board reviews the Company’s quarterly performance against a number of key financial and non-financial measures:
The Board considers the key performance measures over various time periods and against similar funds. A record of these measures is disclosed in the Financial highlights and performance summary, the Chairman's statement and the Investment Manager's report.
EPRA performance measures
EPRA Best Practice Recommendations have been disclosed to facilitate comparison with the Company’s peers through consistent reporting of key real estate specific performance measures.
Debt financing
The Company operates with a conservative level of net gearing, with target borrowings over the medium-term of 25% of the aggregate market value of all properties at the time of drawdown. The Company’s net gearing decreased from 24.9% LTV last year to 19.1% at the year end primarily due to £94.0m of valuation increases.
Since the year end the Company has arranged a £25m tranche of 10 year debt with Aviva at a fixed rate of interest of 4.10% per annum to refinance a £25m variable rate revolving credit facility with RBS, acquired via the DRUM REIT acquisition. Following the refinancing the Company had the following facilities available:
Each facility has a discrete security pool, comprising a number of the Company’s individual properties, over which the relevant lender has security and the following covenants:
At the year end the Company had £207.2m (31% of the property portfolio) of unencumbered assets which could be charged to the security pools to enhance the LTV on the individual loans. During the year the Company charged unencumbered properties valued at £30.3m to certain facilities as substitutions for charged properties sold during the year. Since the year end £53.5m of unencumbered property has been charged to the new £25m tranche of debt with Aviva with charges over £49.0m of property secured on the £25m RCF with RBS released on that facility’s subsequent cancellation.
The weighted average cost (“WAC”) of the Company’s agreed debt facilities at 31 March 2022 was 3.0% (2021: 3.0%), with a weighted average maturity (“WAM”) of 5.2 years (2021: 7.4 years). At 31 March 2022 the Company had £nil drawn under its Lloyds RCF and £22.8m drawn under its RBS RCF, meaning 84% (2021: 82%) of the Company’s drawn debt facilities, and 61% (2021: 70%) of its agreed debt facilities, were at fixed rates.
On completion of the new tranche of Aviva debt and repayment and cancellation of the £25m RCF with RBS, the Company’s WAC of its agreed debt facilities increases to 3.2% with 74% at a fixed rate of interest and a WAM of 6.3 years.
This high proportion of fixed rate debt significantly mitigates long-term interest rate risk for the Company and provides shareholders with a beneficial margin between the fixed cost of debt and income returns from the property portfolio.
LIBOR, the London Inter Bank Offer Rate interest rate benchmark used for setting the interest rate charged on the Company’s RCF facilities was discontinued during the year and has been replaced by SONIA. The transition has not had a material impact on the interest rates on the RCFs.
Outlook
The Company’s business model has remained resilient during the year and we have further mitigated against interest rate rises by refinancing £25m of variable rate debt at a fixed rate. We have a scalable cost structure and flexible capital structure to be on the front foot when opportunities present themselves to raise new equity and exploit acquisition opportunities.
Ed Moore Finance Director for and on behalf of Custodian Capital Limited Investment Manager 16 June 2022 Property portfolio
Industrial
*Tenants in occupation paying £nil rent through CVAs where ERV has been used to calculate % portfolio income.
Principal risks and uncertainties
The Board has overall responsibility for reviewing the effectiveness of the system of risk management and internal control which is operated by the Investment Manager. The Company’s risk management process is designed to identify, evaluate and mitigate the significant risks the Company faces. At least annually, the Board undertakes a risk review, with the assistance of the Audit and Risk Committee, to assess the effectiveness of the Investment Manager’s risk management and internal control systems. During this review, no significant failings or weaknesses were identified in respect of risk management, internal control and related financial and business reporting.
The Company holds a portfolio of high quality property let to institutional grade tenants and is primarily financed by fixed rate debt. It does not undertake speculative development.
There are a number of potential risks and uncertainties which could have a material impact on the Company's performance over the forthcoming financial year and could cause actual results to differ materially from expected and historical results. The Directors have assessed the risks facing the Company, including risks that would threaten the business model, future performance, solvency or liquidity. The table below outlines the principal risks identified, but does not purport to be exhaustive as there may be additional risks that materialise over time that the Company has not yet identified or has deemed not likely to have a potentially material adverse effect on the business.
Emerging risks
The following emerging risks have been identified:
The Board believes the Company is well placed to weather the longer-term impact of these risks because the Company has:
No other emerging risks have been added to the Company’s Risk Register during the year.
Going concern and longer-term viability
In accordance with Provision 31 of the UK Corporate Governance Code 2018 issued by the Financial Reporting Council (“the Code”), the Directors have assessed the prospects of the Company over a period longer than 12 months. The Board resolved to conduct this review for a period of three years, because:
The Directors have assessed the following factors in assessing the Company’s status as a going concern and its longer-term viability, including events up to the date of authorisation of the financial statements:
The Directors note that the Company has performed strongly during the year with rent collection rates back a pre-pandemic levels and industrial valuations and rents in particular improving over the last 12 months.
Results of the assessment
Based on prudent assumptions within the Company’s forecasts regarding losses of contractual rent, tenant default, void rates and property valuation movements, the Directors expect that over the three-year period of their assessment:
Sensitivities
These assessments are subject to sensitivity analysis, which involves flexing a number of key assumptions and judgements included in the financial projections:
This sensitivity analysis also evaluates the potential impact of the principal risks and uncertainties should they occur which, together with the steps taken to mitigate them, are highlighted above and in the Audit and Risk Committee report. The Board seeks to ensure that risks are mitigated appropriately and managed within its risk appetite all times.
Sensitivity analysis considered the following areas:
Covenant compliance
The Company operates the loan facilities summarised in Note 15. At 31 March 2022 the Company had significant headroom on lender covenants at a portfolio level with:
Reverse stress testing has been undertaken to understand what circumstances would result in potential breaches of financial covenants. While the assumptions applied in these scenarios are possible, they do not represent the Board’s view of the likely outturn, but the results help inform the Directors’ assessment of the viability of the Company. The testing indicated that:
The Board notes that the February 2022 IPF Forecasts for UK Commercial Property Investment survey suggests an average 2.5% increase in rents during 2022 with capital value increases of 4.1%. The Board believes that the valuation of the Company’s property portfolio will prove resilient due to its higher weighting to industrial assets and overall diverse and high-quality asset and tenant base comprising 160 assets and over 300 typically 'institutional grade' tenants across all commercial sectors.
Liquidity
At 31 March 2022 the Company had:
The Company’s forecast model projects it will have sufficient cash and undrawn facilities to settle its target dividends and its expense and interest liabilities for a period of at least 12 months.
As detailed in Note 15, the Company’s Lloyds RCF expires in September 2024. The Board anticipates lender support in agreeing subsequent facilities, and would seek to refinance the RCF with another lender or dispose of sufficient properties to repay it in September 2024 in the unlikely event of lender support being withdrawn.
Impact of emerging risks
The Board believes it too early to understand fully the longer-term impact of the COVID-19 pandemic, Brexit and the war in Ukraine but the Board believes the Company is well placed to weather any shorter-term impacts due to the reasons set out in the Principal risks and uncertainties section.
Section 172 statement and stakeholder relationships
The Directors consider that in conducting the business of the Company over the course of the year they have complied with Section 172(1) of the Companies Act 2006 (“the Act”) by fulfilling their duty to promote the success of the Company and act in the way they consider, in good faith, would be most likely to promote the success of the Company for the benefit of its members as a whole.
Issues, factors and stakeholders
The Board has direct engagement with the Company’s shareholders and seeks a rounded and balanced understanding of the broader impact of its decisions through regular engagement with its stakeholder groups (detailed below) to understand their views, typically through feedback from the Investment Manager and the Company’s broker, which is regularly communicated to the Board via quarterly meetings. Stakeholder engagement also ensures the Board is kept aware of any significant changes in the market, including the identification of emerging trends and risks, which in turn can be factored into its strategy discussions.
Management of the Company’s day-to-day operations has been delegated to the Investment Manager, Custodian Capital Limited, and the Company has no employees. This externally managed structure allows the Board and the Investment Manager to have due regard to the impact of decisions on the following matters specified in Section 172 (1) of the Act:
Methods used by the Board
The main methods used by the Directors to perform their duties include:
Principal decisions in the year
The Board has delegated operational functions to the Investment Manager and other key service providers. In particular, responsibility for management of the Company’s property portfolio has been delegated to the Investment Manager. The Board retains responsibility for reviewing the engagement of the Investment Manager and exercising overall control of the Company, reserving certain key matters as set out in the Governance report.
The principal non-routine decisions taken by the Board during the year were:
Due to the nature of these decisions, a variety of stakeholders had to be factored into the Board’s discussions. Each decision was announced at the time, so that all stakeholders were aware of the decisions.
Stakeholders
The Board recognises the importance of stakeholder engagement to deliver its strategic objectives and believes its stakeholders are vital to the continued success of the Company. The Board is mindful of stakeholder interests and keeps these at the forefront of business and strategic decisions. Regular engagement with stakeholders is fundamental to understanding their views. The below section highlights how the Company engages with its key stakeholders, why they are important and the impact they have on the Company and therefore its long-term success, which the Board believes helps demonstrate the successful discharge of its duties under s172(1) of the Act.
Approval of Strategic report
The Strategic report, (incorporating the Business model and strategy, Chairman’s statement, Investment Manager’s report, Asset management report, ESG Committee report, Financial report, Property portfolio, Principal risks and uncertainties and Section 172 statement and stakeholder relationships) was approved by the Board of Directors and signed on its behalf by:
David Hunter Chairman 16 June 2022 Board of Directors and Investment Manager personnel
The Board currently comprises seven non-executive directors. A short biography of each director is set out below:
David Hunter - Independent Chairman, age 68
David is a professional non-executive director and strategic adviser focused principally on UK and international real estate. He chairs the Company and its Nominations Committee and is on the boards of both listed and unlisted companies in the UK and overseas, as well as holding corporate advisory roles. He qualified as a chartered surveyor in 1978 and has over 25 years’ experience as a fund manager, including as Managing Director of Aberdeen Asset Management’s property fund business. David is a former President of the British Property Federation and was actively involved in the introduction of REITs to the UK. He is also Honorary Swedish Consul to Glasgow and an Honorary Professor of real estate at Heriot-Watt University.
David is Non-Executive Chair of Capital & Regional plc (“C&R”). The Board perceives no material conflicts of interest between Custodian REIT and the activities of C&R due to their divergent property strategies.
David’s other roles are not considered to impact his ability to allocate sufficient time to the Company to discharge his responsibilities effectively.
Elizabeth McMeikan – Senior Independent Director, age 60
Elizabeth joined the Board as Senior Independent Director (“SID”) on 1 April 2021. Her substantive executive career was with Tesco plc where she was a Stores Board Director before embarking on a non-executive career in 2005.
Elizabeth is currently SID and Remuneration Committee Chair at The Unite Group Plc, the UK's largest owner, manager and developer of purpose-built student accommodation and Non-Executive Director and ESG Committee Chair of Dalata Hotel Group plc, the largest hotel group in the Republic of Ireland. Her other Board roles include Non-Executive Director and Remuneration Committee Chair at McBride plc, Europe’s leading manufacturer of cleaning and hygiene products, and Non-Executive Director of Fresca Group Limited, a fruit and vegetable import/export company.
Previously she was SID of JD Wetherspoon plc, SID and Remuneration Committee Chair of Flybe plc and Chair of Moat Homes Limited.
Elizabeth’s other roles are not considered to impact her ability to allocate sufficient time to the Company to discharge her responsibilities effectively.
Matthew Thorne FCA - Independent Director, age 69
Matthew chairs the Company’s Audit and Risk Committee. Matthew qualified as a chartered accountant in 1978 with Price Waterhouse. He was an independent non-executive director for nine years of Bankers Investment Trust plc, retiring in 2018 having chaired the Audit Committee. Since May 2007 Matthew has been an adviser to Consensus Business Group (led by Vincent Tchenguiz). Matthew was also Audit Committee chair and the finance member of the Advisory Board and Advisory Panel of Greenwich Hospital, the Naval Charity, until January 2020. Matthew’s previous executive roles have included Group Finance Director of McCarthy & Stone plc from 1993 to 2007, Finance Director of Ricardo plc from 1991 to 1992 and Investment Director of Beazer plc from 1983 to 1991.
Matthew is expected to retire from the Board at the AGM on 31 August 2022.
Hazel Adam - Independent Director, age 53
Hazel was an investment analyst with Scottish Life until 1996 and then joined Standard Life Investments. As a fund manager she specialised in UK and then Emerging Market equities. In 2005 Hazel joined Goldman Sachs International as an executive director on the new markets equity sales desk before moving to HSBC in 2012, holding a similar equity sales role until 2016.
Hazel is an independent non-executive director of Aberdeen Latin American Income Fund Limited and holds the CFA Level 4 certificate in ESG Investing and the Financial Times Non-Executive Directors Diploma.
Hazel’s other role is not considered to impact her ability to allocate sufficient time to the Company to discharge her responsibilities effectively.
Chris Ireland FRICS - Independent Director, age 64
Chris was appointed as an Independent Director on 1 April 2021. Chris joined international property consultancy King Sturge in 1979 as a graduate and has worked his whole career across the UK investment property market. He ran the investment teams at King Sturge before becoming Joint Managing Partner and subsequently Joint Senior Partner prior to its merger with JLL in 2011.
Chris was appointed as Chief Executive Officer of JLL UK in 2016 and became its Chair in April 2021. He will continue to play an active role in the capital markets business and is committed to leading the property sector on sustainability and supporting the debate around the climate emergency.
Chris is a former Chair of the Investment Property Forum and is a Non-Executive Director of Le Masurier, a Jersey based family trust with assets across the UK, Germany and Jersey. Chris is also a keen supporter of the UK homelessness charity Crisis.
Chris’ other roles are not considered to impact his ability to allocate sufficient time to the Company to discharge his responsibilities effectively.
Malcolm Cooper FCCA FCT - Independent Director, age 63
Malcolm was appointed to the Board on 6 June 2022.
He is a qualified accountant and an experienced FTSE 250 company Audit Committee Chair with an extensive background in corporate finance and a wide experience in infrastructure and property.
Malcolm worked with Arthur Andersen and British Gas/BG Group/Lattice before spending 15 years with National Grid with roles including Managing Director of National Grid Property and Global Tax and Treasury Director, and culminated in the successful sale of a majority stake in National Grid’s gas distribution business, now known as Cadent Gas.
Malcolm is currently a Non-Executive Director of Morgan Sindall Group plc, a FTSE 250 UK construction and regeneration business, Chairing its Audit and Responsible Business Committees. He is also Senior Independent Director of MORhomes plc, Non-Executive Director and Audit Committee Chair at Southern Water Services Limited and Non-Executive Director and Audit and Risk Committee Chair at Local Pensions Partnership Investment.
Malcolm was previously Senior Independent Director and Audit Committee chair at CLS Holdings plc, a Non-Executive Director of St William Homes LLP, President of the Association of Corporate Treasurers and a member of the Financial Conduct Authority’s Listing Authority Advisory Panel.
Malcolm’s other roles are not considered to impact his ability to allocate sufficient time to the Company to discharge his responsibilities effectively.
Ian Mattioli MBE - Director, age 59
Ian is CEO of Mattioli Woods plc (“Mattioli Woods”) with over 35 years’ experience in financial services, wealth management and property businesses and is the founder director of Custodian REIT. Together with Bob Woods, Ian founded Mattioli Woods, the AIM-listed wealth management and employee benefits business which is the parent company of the Investment Manager. Mattioli Woods now has over £15bn of assets under management, administration and advice. Ian is responsible for the vision and operational management of Mattioli Woods and instigated the development of its investment proposition, including the syndicated property initiative that developed into the seed portfolio for the launch of Custodian REIT. His personal achievements include winning the London Stock Exchange AIM Entrepreneur of the Year award and CEO of the year in the 2018 City of London wealth management awards.
Ian was awarded an MBE in the Queen's 2017 New Year's Honours list for his services to business and the community in Leicestershire and was appointed High Sheriff of Leicestershire in March 2021, an independent non-political Royal appointment for a single year. Ian is also Non-Executive Chair of K3 Capital Group plc, which is listed on AIM and specialises in business transfer, business brokerage and corporate finance across the UK.
Ian’s other roles are not considered to impact his ability to allocate sufficient time to the Company to discharge his responsibilities effectively.
Investment Manager personnel
Short biographies of the Investment Manager’s key personnel and senior members of its property team are set out below:
Richard Shepherd-Cross MRICS - Managing Director
Richard qualified as a Chartered Surveyor in 1996 and until 2008 worked for JLL, latterly running its national portfolio investment team.
Since joining Mattioli Woods in 2009, Richard established Custodian Capital as the Property Fund Management subsidiary to Mattioli Woods and in 2014 was instrumental in the establishment of Custodian REIT plc from Mattioli Woods’ syndicated property portfolio and its 1,200 investors. Following the successful IPO of the Company, Richard has overseen the growth of the Company to its current property portfolio of over £0.6bn. Richard and his family own 371,381 shares in the Company.
Ed Moore FCA – Finance Director
Ed qualified as a Chartered Accountant in 2003 with Grant Thornton, specialising in audit, financial reporting and internal controls across its Midlands practice. He is Finance Director of Custodian Capital with responsibility for all day-to-day financial aspects of its operations. Ed is also a member of the Custodian Capital Investment Committee.
Since IPO in 2014 Ed has overseen the Company raising over £300m of new equity, arranging or refinancing seven loan facilities and completing four corporate acquisitions, including leading on the acquisition of DRUM REIT. Ed’s key responsibilities for Custodian REIT are accurate external and internal financial reporting, ongoing regulatory compliance and maintaining a robust control environment. Ed is Company Secretary of Custodian REIT and is a member of the Investment Manager’s Investment Committee. Ed is also responsible for the Investment Manager’s environmental initiatives, attending Custodian REIT ESG Committee meetings and co-leading the Investment Manger’s ESG working group.
Ian Mattioli MBE - Founder and Chair
Ian’s biography is set out above.
Alex Nix MRICS – Assistant Investment Manager
Alex graduated from Nottingham Trent University with a degree in Real Estate Management before joining Lambert Smith Hampton, where he spent eight years and qualified as a Chartered Surveyor in 2006.
Alex is Assistant Investment Manager to Custodian REIT having joined Custodian Capital in 2012. Alex heads the Company’s property management and asset management initiatives, assists in sourcing and executing new investments and is a member of the Investment Manager’s Investment Committee.
Tom Donnachie MRICS – Portfolio Manager
Tom graduated from Durham University with a degree in Geography before obtaining an MSc in Real Estate Management from Sheffield Hallam University. Tom worked in London for three years where he qualified as a Chartered Surveyor with Workman LLP before returning to the Midlands first with Lambert Smith Hampton and then CBRE.
Tom joined Custodian Capital in 2015 as Portfolio Manager with a primary function to maintain and enhance the existing property portfolio and assist in the selection and due diligence process regarding new acquisitions. Tom co-leads the Investment Manager’s environmental working group and attends Custodian REIT ESG Committee meetings.
Javed Sattar MRICS – Portfolio Manager
Javed joined Custodian Capital in 2011 after graduating from Birmingham City University with a degree in Estate Management Practice. Whilst working as a trainee surveyor on Custodian REIT’s property portfolio for Custodian Capital he completed a PGDip in Surveying via The College of Estate Management and qualified as a Chartered Surveyor in 2017.
Javed operates as Portfolio Manager managing properties predominantly located in the North-West of England.
Consolidated statements of comprehensive income For the year ended 31 March 2022
The profit for the year arises from continuing operations. Consolidated and Company statements of financial position As at 31 March 2022 Registered number: 08863271
These consolidated and Company financial statements of Custodian REIT plc were approved and authorised for issue by the Board of Directors on 16 June 2022 and are signed on its behalf by:
David Hunter Chairman Consolidated and Company statements of cash flows For the year ended 31 March 2022
Consolidated statement of changes in equity For the year ended 31 March 2022
Company statement of changes in equity For the year ended 31 March 2022
The Company is a public limited company incorporated and domiciled in England and Wales, whose shares are publicly traded on the London Stock Exchange plc’s main market for listed securities. The consolidated financial statements have been prepared on a historical cost basis, except for the revaluation of investment property, and are presented in pounds sterling with all values rounded to the nearest thousand pounds (£000), except when otherwise indicated. The consolidated financial statements were authorised for issue in accordance with a resolution of the Directors on 16 June 2022.
The consolidated financial statements and the separate financial statements of the parent company have been prepared in accordance with international accounting standards in conformity with the requirements of the Companies Act 2006 and International Financial Reporting Standards adopted by the UK. The financial statements have also been prepared in accordance with International Financial Reporting Standards as issued by the IASB.
Certain statements in this report are forward looking statements. By their nature, forward looking statements involve a number of risks, uncertainties or assumptions that could cause actual results or events to differ materially from those expressed or implied by those statements. Forward looking statements regarding past trends or activities should not be taken as representation that such trends or activities will continue in the future. Accordingly, undue reliance should not be placed on forward looking statements.
The consolidated financial statements consolidate those of the parent company and its subsidiaries. The parent controls a subsidiary if it is exposed, or has rights, to variable returns from its involvement with the subsidiary and has the ability to affect those returns through its power over the subsidiary. Custodian Real Estate Limited has a reporting date in line with the Company. Other subsidiaries have September or December accounting reference dates which have not been amended since their acquisition as those companies are expected to be liquidated during the next financial year. All transactions and balances between group companies are eliminated on consolidation, including unrealised gains and losses on transactions between group companies. Where unrealised losses on intra-group asset sales are reversed on consolidation, the underlying asset is also tested for impairment from a group perspective. Amounts reported in the financial statements of the subsidiary are adjusted where necessary to ensure consistency with the accounting policies adopted by the Group. Profit or loss and other comprehensive income of subsidiaries acquired or disposed of during the year are recognised from the effective date of acquisition, or up to the effective date of disposal, as applicable.
Where property is acquired, via corporate acquisitions or otherwise, the substance of the assets and activities of the acquired entity are considered in determining whether the acquisition represents a business combination or an asset purchase under IFRS 3 - Business Combinations. Where such acquisitions are not judged to be a business combination the cost to acquire the corporate entity is allocated between the identifiable assets and liabilities of the entity based on their relative fair values at the acquisition date. Accordingly, no goodwill or additional deferred taxation arises. Otherwise, acquisitions are accounted for as business combinations using the acquisition method.
During the year the Company adopted the following new standards with no impact on reported financial performance or position:
IFRS 17 became effective for periods commencing on or after 1 January 2021. IFRS 17 establishes the principles for the recognition, measurement, presentation and disclosure of insurance contracts and supersedes IFRS 4 Insurance Contracts.
At the date of authorisation of these financial statements, there were no new and revised IFRSs which have not been applied in these financial statements were in issue but not yet effective.
The principal accounting policies adopted by the Group and Company and applied to these financial statements are set out below.
Going concern
The Directors believe the Company is well placed to manage its business risks successfully and the Company’s projections show that it should be able to operate within the level of its current financing arrangements for at least the next 12 months, set out in more detail in the Directors’ report and Principal risks and uncertainties section of the Strategic report. Accordingly, the Directors continue to adopt the going concern basis for the preparation of the financial statements.
Income recognition
Contractual revenues are allocated to each performance obligation of a contract and revenue is recognised on a basis consistent with the transfer of control of goods or services. Revenue is measured at the fair value of the consideration received, excluding discounts, rebates, VAT and other sales taxes or duties.
Rental income from operating leases on properties owned by the Company is accounted for on a straight-line basis over the term of the lease. Rental income excludes service charges and other costs directly recoverable from tenants.
Lease incentives are recognised on a straight-line basis over the lease term.
Revenue and profits on the sale of properties are recognised on the completion of contracts. The amount of profit recognised is the difference between the sale proceeds and the carrying amount.
Finance income relates to bank interest receivable and amounts receivable on ongoing development funding contracts.
Taxation
The Group operates as a REIT and hence profits and gains from the property rental business are normally expected to be exempt from corporation tax. The tax expense represents the sum of the tax currently payable and deferred tax relating to the residual (non-property rental) business. The tax currently payable is based on taxable profit for the year. Taxable profit differs from net profit as reported in the statement of comprehensive income because it excludes items of income and expense that are taxable or deductible in other years and it further excludes items that are never taxable or deductible. The Company’s liability for current tax is calculated using tax rates that have been enacted or substantively enacted by the reporting date.
Investment property
Investment property is held to earn rentals and/or for capital appreciation and is initially recognised at cost including direct transaction costs. Investment property is subsequently valued externally on a market basis at the reporting date and recorded at valuation. Any surplus or deficit arising on revaluing investment property is recognised in profit or loss in the year in which it arises. Dilapidations receipts are held in the statement of financial position and offset against subsequent associated expenditure. Any ultimate gains or shortfalls are measured by reference to previously published valuations and recognised in profit or loss, offset against any directly corresponding movement in fair value of the investment properties to which they relate.
Group undertakings
Investments are included in the Company only statement of financial position at cost less any provision for impairment.
Non-listed equity investments
Non-listed equity investments are classified at fair value through profit and loss and are subsequently measured using level 3 inputs, meaning valuation techniques for which the lowest level input that is significant to the fair value measurement is unobservable.
Financial assets
The Company’s financial assets include cash and cash equivalents and trade and other receivables. Interest resulting from holding financial assets is recognised in profit or loss on an accruals basis.
Loans and receivables are measured subsequent to initial recognition at amortised cost using the effective interest method, less provision for impairment. Provision for impairment of trade and other receivables is made when objective evidence is received that the Company will not be able to collect all amounts due to it in accordance with the original terms of the receivable. The amount of the impairment is determined as the difference between the asset’s carrying amount and the present value of estimated future cash flows, discounted at the effective rate computed at initial recognition. Any change in value through impairment or reversal of impairment is recognised in profit or loss.
A financial asset is de-recognised only where the contractual rights to the cash flows from the asset expire or the financial asset is transferred and that transfer qualifies for de-recognition. A financial asset is transferred if the contractual rights to receive the cash flows of the asset have been transferred or the Company retains the contractual rights to receive the cash flows of the asset but assumes a contractual obligation to pay the cash flows to one or more recipients. A financial asset that is transferred qualifies for de-recognition if the Company transfers substantially all the risks and rewards of ownership of the asset.
Cash and cash equivalents
Cash and cash equivalents include cash in hand and on-demand deposits, and other short-term highly liquid investments that are readily convertible into a known amount of cash and are subject to an insignificant risk of changes in value.
Financial liabilities and equity
Financial liabilities and equity instruments are classified according to the substance of the contractual arrangements entered into. An equity instrument is any contract that evidences a residual interest in the assets of the Company after deducting all of its liabilities. Equity instruments issued by the Company are recorded at the proceeds received, net of direct issue costs.
Share capital represents the nominal value of equity shares issued. Share premium represents the excess over nominal value of the fair value of the consideration received for equity shares, net of direct issue costs.
Retained earnings include all current and prior year results as disclosed in profit or loss. Retained earnings include realised and unrealised profits. Profits are considered unrealised where they arise from movements in the fair value of investment properties that are considered to be temporary rather than permanent.
Bank borrowings
Interest-bearing bank loans and overdrafts are recorded at the fair value of proceeds received, net of direct issue costs. Finance charges, including premiums payable on settlements or redemption and direct issue costs, are accounted for on an accruals basis in profit or loss using the effective interest rate method and are added to the carrying amount of the instrument to the extent that they are not settled in the period in which they arise.
Trade payables
Trade payables are initially measured at fair value and are subsequently measured at amortised cost, using the effective interest rate method.
Leases
Where an investment property is held under a leasehold interest, the headlease is initially recognised as an asset at cost plus the present value of minimum ground rent payments. The corresponding rental liability to the head leaseholder is included in the balance sheet as a liability. Lease payments are apportioned between the finance charge and the reduction of the outstanding liability so as to produce a constant periodic rate of interest on the remaining lease liability.
Segmental reporting
An operating segment is a distinguishable component of the Company that engages in business activities from which it may earn revenues and incur expenses, whose operating results are regularly reviewed by the Company’s chief operating decision maker (the Board) to make decisions about the allocation of resources and assessment of performance and about which discrete financial information is available. As the chief operating decision maker reviews financial information for, and makes decisions about the Company’s investment properties as a portfolio, the Directors have identified a single operating segment, that of investment in commercial properties.
Key sources of judgements and estimation uncertainty
The preparation of the financial statements requires the Company to make estimates and assumptions that affect the reported amount of revenues, expenses, assets and liabilities and the disclosure of contingent liabilities. If in the future such estimates and assumptions, which are based on the Directors’ best judgement at the date of preparation of the financial statements, deviate from actual circumstances, the original estimates and assumptions will be modified as appropriate in the period in which the circumstances change.
Judgements
The areas where a higher degree of judgement or complexity arises are discussed below:
Estimates
Areas where accounting estimates are significant to the financial statements are:
Basic EPS amounts are calculated by dividing net profit for the year attributable to ordinary equity holders of the Company by the weighted average number of ordinary shares outstanding during the year.
Diluted EPS amounts are calculated by dividing the net profit attributable to ordinary equity holders of the Company by the weighted average number of ordinary shares outstanding during the year plus the weighted average number of ordinary shares that would be issued on the conversion of all the dilutive potential ordinary shares into ordinary shares. There are no dilutive instruments in issue. Any shares issued after the year end are disclosed in Note 20.
The Company is a FTSE EPRA/NAREIT index series constituent and EPRA performance measures have been disclosed to facilitate comparability with the Company’s peers through consistent reporting of key performance measures. EPRA has issued recommended bases for the calculation of EPS which the Directors consider are better indicators of performance.
Operating profit is stated after (crediting)/charging:
Fees payable to the Company’s auditor, Deloitte LLP, are further detailed in the Audit and Risk Committee report.
The tax charge assessed for the year is lower than the standard rate of corporation tax in the UK during the year of 19.0%. The differences are explained below:
The Company operates as a REIT and hence profits and gains from the property investment business are normally exempt from corporation tax.
The Company paid a fourth interim dividend relating to the quarter ended 31 March 2022 of 1.375p per ordinary share (totalling £6.1m) on 31 May 2022 to shareholders on the register at the close of business on 13 May 2022 which has not been included as liabilities in these financial statements.
£458.0m (2021: £391.9m) of investment property was charged as security against the Company’s borrowings at the year end. £0.6m (2021: £0.6m) of investment property comprises right-of-use assets.
The carrying value of investment property at 31 March 2022 comprises £557.8m freehold (2021: £444.1m) and £107.4m leasehold property (2021: £107.8m).
Investment property is stated at the Directors’ estimate of its 31 March 2022 fair value. Savills (UK) Limited (“Savills”) and Knight Frank LLP (“KF”), professionally qualified independent valuers, each valued approximately half of the property portfolio as at 31 March 2022 in accordance with the Appraisal and Valuation Standards published by the Royal Institution of Chartered Surveyors (“RICS”). Savills and KF have recent experience in the relevant locations and categories of the property being valued.
Investment property has been valued using the investment method which involves applying a yield to rental income streams. Inputs include yield, current rent and ERV. For the year end valuation, the equivalent yields used ranged from 4.3% to 12.3%. Valuation reports are based on both information provided by the Company e.g. current rents and lease terms, which are derived from the Company’s financial and property management systems and are subject to the Company’s overall control environment, and assumptions applied by the valuers e.g. ERVs and yields. These assumptions are based on market observation and the valuers’ professional judgement. In estimating the fair value of each property, the highest and best use of the properties is their current use.
All other factors being equal, a higher equivalent yield would lead to a decrease in the valuation of investment property, and an increase in the current or estimated future rental stream would have the effect of increasing capital value, and vice versa. However, there are interrelationships between unobservable inputs which are partially determined by market conditions, which could impact on these changes.
Shares in subsidiaries
* Held indirectly
The Company’s non-trading UK subsidiaries have claimed the audit exemption available under Section 479A of the Companies Act 2006. The Company’s registered office is also the registered office of each UK subsidiary.
Custodian Real Estate (JMP4) Limited was dissolved on 18 April 2022.
DRUM REIT acquisition
The acquisition of DRUM REIT during the year has been accounted for as an asset acquisition. Consideration of £19.1m comprised the issue of 20,247,040 shares at their market value of 94.5p. This consideration was allocated between the fair value of the acquired assets and liabilities of DRUM REIT comprising £0.15m of working capital, £22.7m of net borrowings and £41.65m of investment property.
Non-listed equity investments
The Company was allotted 4.5% of the ordinary share capital of AGO Hotels Limited on 31 January 2021 as part of a new letting of its hotel asset in Portishead.
The Company regularly monitors the effectiveness of the criteria used to identify whether there has been a significant increase in credit risk and revises them as appropriate to ensure that the criteria are capable of identifying significant increases in credit risk before amounts become past due.
The Company considers the following as constituting an event of default for internal credit risk management purposes as historical experience indicates that financial assets that meet either of the following criteria are generally not recoverable:
Such balances are provided for in full. For remaining balances the Company has applied an expected credit loss (“ECL”) matrix based on its experience of collecting rent arrears. The ECL matrix fully provides for receivable balances more than 180 days past due and partially provides against receivable balances between 60 and 180 days past due.
The decrease in provision during the year is due to the collection of previously provided for debts.
Tenant rent deposits of £1.1m (2021: £0.9m) are held as collateral against certain trade receivable balances.
The Directors consider that the carrying amount of trade and other payables approximates to their fair value. Trade payables and accruals principally comprise amounts outstanding for trade purchases and ongoing costs. For most suppliers interest is charged if payment is not made within the required terms. Thereafter, interest is chargeable on the outstanding balances at various rates. The Company has financial risk management policies in place to ensure that all payables are paid within the credit timescale.
Amounts payable to subsidiary undertakings are due on demand.
Group and Company cash and cash equivalents at 31 March 2022 include £1.7m (2021: £2.6m) of restricted cash comprising: £1.1m (2021: £0.9m) rental deposits held on behalf of tenants, £0.3m (2021: £nil) exchange deposits on pipeline acquisitions, £0.3m (2021: £0.2m) retentions held in respect of development fundings and £nil (2021: £1.5m) interest prepayments.
During the year the Company and Lloyds agreed to extend the term of the RCF by one year to expire in 2024.
At the year end the Company has the following facilities available:
Each facility has a discrete security pool, comprising a number of the Company’s individual properties, over which the relevant lender has security and covenants:
The Company’s debt facilities contain market-standard cross-guarantees such that a default on an individual facility will result in all facilities falling into default.
Since the year end the Company has arranged a £25m tranche of 10 year debt with Aviva at a fixed rate of interest of 4.10% per annum to refinance the £25m variable rate revolving credit facility with RBS.
During the year, the Company raised £19.7m (before costs and expenses) through the placing of 20,797,054 new ordinary shares.
Rights, preferences and restrictions on shares
All ordinary shares carry equal rights and no privileges are attached to any shares in the Company. All the shares are freely transferable, except as otherwise provided by law. The holders of ordinary shares are entitled to receive dividends as declared from time to time and are entitled to one vote per share at meetings of the Company. All shares rank equally with regard to the Company’s residual assets.
At the AGM of the Company held on 25 August 2021, the Board was given authority to issue up to 140,201,115 shares, pursuant to section 551 of the Companies Act 2006 (“the Authority”). The Authority is intended to satisfy market demand for the ordinary shares and raise further monies for investment in accordance with the Company’s investment policy. 20,797,054 ordinary shares have been issued under the Authority since 25 August 2021, leaving an unissued balance of 119,404,061 at 31 March 2022. The Authority expires on the earlier of 15 months from 25 August 2021 and the subsequent AGM, due to take place on 31 August 2022.
In addition, the Company was granted authority to make market purchases of up to 42,060,344 ordinary shares under section 701 of the Companies Act 2006. No market purchases of ordinary shares have been made.
The nature and purpose of each reserve within equity are:
Company as lessor
Operating leases, in which the Company is the lessor, relate to investment property owned by the Company with lease terms of between 0 to 15 years. The aggregated future minimum rentals receivable under all non-cancellable operating leases are:
The following table presents amounts reported in revenue:
Save for transactions described below, the Company is not a party to, nor had any interest in, any other related party transaction during the year.
Transactions with directors
Each of the directors is engaged under a letter of appointment with the Company and does not have a service contract with the Company. Under the terms of their appointment, each director is required to retire by rotation and seek re-election at least every three years. Each director’s appointment under their respective letter of appointment is terminable immediately by either party (the Company or the director) giving written notice and no compensation or benefits are payable upon termination of office as a director of the Company becoming effective.
Ian Mattioli is Chief Executive of Mattioli Woods, the parent company of the Investment Manager, and is a director of the Investment Manager. As a result, Ian Mattioli is not independent. The Company Secretary, Ed Moore, is also a director of the Investment Manager.
Investment Management Agreement
The Investment Manager is engaged as AIFM under an IMA with responsibility for the management of the Company’s assets, subject to the overall supervision of the Directors. The Investment Manager manages the Company’s investments in accordance with the policies laid down by the Board and the investment restrictions referred to in the IMA. The Investment Manager also provides day-to-day administration of the Company and acts as secretary to the Company, including maintenance of accounting records and preparing the annual and interim financial statements of the Company.
On 22 June 2020 the terms of the IMA were varied to secure the appointment of the Investment Manager for a further three years, with a further year’s notice, and to introduce further fee hurdles such that annual management fees payable to the Investment Manager under the IMA are now:
Administrative fees payable to the Investment Manager under the IMA are now:
The IMA is terminable by either party by giving not less than 12 months’ prior written notice to the other, which notice may only be given after the expiry of the Initial three year term. The IMA may also be terminated on the occurrence of an insolvency event in relation to either party, if the Investment Manager is fraudulent, grossly negligent or commits a material breach which, if capable of remedy, is not remedied within three months, or on a force majeure event continuing for more than 90 days.
The Investment Manager receives a marketing fee of 0.25% (2021: 0.25%) of the aggregate gross proceeds from any issue of new shares in consideration of the marketing services it provides to the Company.
During the year the Investment Manager charged the Company £4.41m (2021: £3.75m) comprising £3.86m (2021: £3.33m) in respect of annual management fees, £0.46m (2021: £0.42m) in respect of administrative fees, £nil (2021: £nil) in respect of marketing fees and a transaction fee of £0.09m relating to work carried out on the acquisition of DRUM REIT.
Mattioli Woods arranges insurance on behalf of the Company’s tenants through an insurance broker and the Investment Manager is paid a commission by the Company’s tenants for administering the policy.
Capital risk management
The Company manages its capital to ensure it can continue as a going concern while maximising the return to stakeholders through the optimisation of the debt and equity balance within the parameters of its investment policy. The capital structure of the Company consists of debt, which includes the borrowings disclosed below, cash and cash equivalents and equity attributable to equity holders of the parent, comprising issued ordinary share capital, share premium and retained earnings.
Net gearing ratio
The Board reviews the capital structure of the Company on a regular basis. As part of this review, the Board considers the cost of capital and the risks associated with each class of capital. The Company has a target net gearing ratio of 25% determined as the proportion of debt (net of unrestricted cash) to investment property. The net gearing ratio at the year-end was 19.1% (2021: 24.9%).
Externally imposed capital requirements
The Company is not subject to externally imposed capital requirements, although there are restrictions on the level of interest that can be paid due to conditions imposed on REITs.
Financial risk management
The Company seeks to minimise the effects of interest rate risk, credit risk, liquidity risk and cash flow risk by using fixed and floating rate debt instruments with varying maturity profiles, at low levels of net gearing.
Interest rate risk management
The Company’s activities expose it primarily to the financial risks of increases in interest rates, as it borrows funds at floating interest rates. The risk is managed by maintaining:
The Board periodically considers the availability and cost of hedging instruments to assess whether their use is appropriate and also considers the maturity profile of the Company’s borrowings.
Interest rate sensitivity analysis
Interest rate risk arises on interest payable on the RCFs only, as interest on all other debt facilities is payable on a fixed rate basis. At 31 March 2022, the RBS RCF was drawn at £22.8m. Assuming this amount was outstanding for the whole year and based on the exposure to interest rates at the reporting date, if three-month LIBOR/SONIA had been 0.5% higher/lower and all other variables were constant, the Company’s profit for the year ended 31 March 2022 would decrease/increase by £0.1m due to its variable rate borrowings.
Market risk management
The Company manages its exposure to market risk by holding a portfolio of investment property diversified by sector, location and tenant.
Market risk sensitivity
Market risk arises on the valuation of the Company’s property portfolio in complying with its bank loan covenants (Note 15). The Company would breach its overall borrowing covenant if the valuation of its property portfolio fell by 45% (2021: 29%).
Credit risk management
Credit risk refers to the risk that a counterparty will default on its contractual obligations resulting in a financial loss to the Company. The Company’s credit risk is primarily attributable to its trade receivables and cash balances. The amounts included in the statement of financial position are net of allowances for bad and doubtful debts. An allowance for impairment is made where a debtor is in breach of its financial covenants, available information indicates a debtor can’t pay or where balances are significantly past due.
The Company has adopted a policy of only dealing with creditworthy counterparties as a means of mitigating the risk of financial loss from defaults. The maximum credit risk on financial assets at 31 March 2022 was £3.1m (2021: £4.2m).
The Company has no significant concentration of credit risk, with exposure spread over a large number of tenants covering a wide variety of business types. Further detail on the Company’s credit risk management process is included within the Strategic report.
Liquidity risk management
Ultimate responsibility for liquidity risk management rests with the Board, which has built an appropriate liquidity risk management framework for the management of the Company’s short, medium and long-term funding and liquidity management requirements. The Company manages liquidity risk by maintaining adequate reserves, banking facilities and reserve borrowing facilities by continuously monitoring forecast and actual cash flows and matching the maturity profile of financial assets and liabilities.
The following tables detail the Company’s contractual maturity for its financial liabilities. The table has been drawn up based on undiscounted cash flows of financial liabilities based on the earliest date on which the Company can be required to pay. The table includes both interest and principal cash flows.
Fair values
The fair values of financial assets and liabilities are not materially different from their carrying values in the financial statements. The fair value hierarchy levels are as follows:
There have been no transfers between Levels 1, 2 and 3 during the year. The main methods and assumptions used in estimating the fair values of financial instruments and investment property are detailed below.
Investment property – level 3
Fair value is based on valuations provided by an independent firm of chartered surveyors and registered appraisers, which uses the inputs set out in Note 10. These values were determined after having taken into consideration recent market transactions for similar properties in similar locations to the investment properties held by the Company. The fair value hierarchy of investment property is level 3. At 31 March 2021, the fair value of the Company’s investment properties was £665.2m (2021: £551.9m).
Interest bearing loans and borrowings – level 3
As at 31 March 2022 the value of the Company’s loans with Lloyds, RBS, SWIP and Aviva all held at amortised cost was £137.8m (2021: £140.0m). The difference between the carrying value of Company’s loans and their fair value is detailed in Note 21.
Trade and other receivables/payables – level 3
The carrying amount of all receivables and payables deemed to be due within one year are considered to reflect their fair value.
Impact of the COVID-19 pandemic
As set out in the Principal risks and uncertainties section of the Strategic report, the Board believes it too early to understand fully the longer-term impact of the COVID-19 pandemic, but the Board believes the Company is well placed to weather any short-term impact due to the reasons set out in the Strategic report.
The Board does therefore not consider it necessary or possible to carry out sensitivity analysis on its valuation or cashflow assumptions.
Property transactions
Since the year end the Company has acquired:
Since the year end the Company has sold a 25k sq ft car showroom occupied by Audi for £5.6m.
Borrowings
Since the year end the Company has arranged a £25m tranche of 10 year debt with Aviva at a fixed rate of interest of 4.10% per annum to refinance a £25m variable rate revolving credit facility with RBS.
NAV per share total return
A measure of performance taking into account both capital returns and dividends by assuming dividends declared are reinvested at NAV at the time the shares are quoted ex-dividend, shown as a percentage change from the start of the year.
Share price total return
A measure of performance taking into account both share price returns and dividends by assuming dividends declared are reinvested at the ex-dividend share price, shown as a percentage change from the start of the year.
Dividend cover
The extent to which dividends relating to the year are supported by recurring net income.
Net gearing
Gross borrowings less cash (excluding rent deposits), divided by property portfolio value.
Ongoing charges
A measure of the regular, recurring costs of running an investment company expressed as a percentage of average NAV.
EPRA performance measures
EPRA promotes, develops and represents the European public real estate sector, providing leadership in matters of common interest by publishing research and encouraging discussion of issues impacting the property industry, both within the membership and with a wide range of stakeholders, including the EU institutions, governmental and regulatory bodies and business partners. The Board supports EPRA’s drive to bring parity to the comparability and quality of information provided in this report to investors and other key stakeholders.
EPRA earnings per share
A measure of the Company’s operating results excluding gains or losses on investment property, giving a better indication than basic EPS of the extent to which dividends paid in the year are supported by recurring net income.
EPRA NAV per share metrics
EPRA NAV metrics make adjustments to the IFRS NAV to provide stakeholders with the most relevant information on the fair value of the assets and liabilities of a real estate investment company, under different scenarios.
EPRA Net Reinstatement Value (“NRV”)
NRV assumes the Company never sells its assets and aims to represent the value required to rebuild the entity.
EPRA Net Tangible Assets (“NTA”)
Assumes that the Company buys and sells assets for short-term capital gains, thereby crystallising certain deferred tax balances.
EPRA Net Disposal Value (“NDV”)
Represents the shareholders’ value under a disposal scenario, where deferred tax, financial instruments and certain other adjustments are calculated to the full extent of their liability, net of any resulting tax.
The fair value of the liability of Company’s interest-bearing loans included in the balance sheet at amortised cost has been calculated based on prevailing swap rates, and excludes ‘break’ costs chargeable should the Company settle loans ahead of their contractual expiry. At 31 March 2022 all of the Company’s fixed rate debt instruments were ‘in the money’ so no fair value adjustment has been made in calculating EPRA NDV.
EPRA NIY and EPRA ‘topped-up’ NIY
EPRA NIY represents annualised rental income based on cash rents passing at the balance sheet date, less non-recoverable property operating expenses, divided by the gross property valuation. The EPRA ‘topped-up’ NIY is calculated by making an adjustment to the EPRA NIY in respect of the expiration of rent free periods (or other unexpired lease incentives such as discounted rent periods and stepped rents).
EPRA vacancy rate
EPRA vacancy rate is the ERV of vacant space as a percentage of the ERV of the whole property portfolio.
EPRA cost ratios
EPRA cost ratios reflect overheads and operating costs as a percentage of gross rental income.
EPRA capital expenditure
Capital expenditure incurred on the Company’s property portfolio during the year.
EPRA like-for-like rental growth
Like-for-like rental growth of the property portfolio by sector.
Distribution of the Annual Report and accounts to members
The financial information set out above does not constitute the Company's statutory accounts for the years ended 31 March 2022 or 2021, but is derived from those accounts. Statutory accounts for 2021 have been delivered to the Registrar of Companies and those for 2022 will be delivered following the Company's AGM. The auditor has reported on the 2022 accounts: their report was unqualified, did not draw attention to any matters by way of emphasis and did not contain statements under s498(2) or (3) of the Companies Act 2006. The Annual Report and accounts will be posted to shareholders in due course, and will be available on our website (custodianreit.com) and for inspection by the public at the Company’s registered office address: 1 New Walk Place, Leicester LE1 6RU during normal business hours on any weekday. Further copies will be available on request.
- Ends - [1] The European Public Real Estate Association (“EPRA”). |
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| ISIN: | GB00BJFLFT45 |
| Category Code: | MSCM |
| TIDM: | CREI |
| LEI Code: | 2138001BOD1J5XK1CX76 |
| Sequence No.: | 168905 |
| EQS News ID: | 1377669 |
| End of Announcement | EQS News Service |
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