For release 7 August 2019
Ground Rents Income Fund plc
Company update following review of the strategy and dividend policy
Following the appointment of Schroder Real Estate Investment Management Limited ("Schroders" or the "Manager") as the Company's Alternative Investment Fund Manager first announced on 11 April 2019, the Board of Ground Rents Income Fund plc ("GRIO" or the "Company") announced its intention to undertake a review of the strategy to determine the best course to maximise sustainable shareholder total returns including a review of the dividend policy.
Strategic focus
The Company's strategy is to invest in long-dated UK ground rents which have historically had a low correlation to traditional real estate sectors. In other parts of the real estate market there is strong demand for investments offering similar, annuity-style cash flows and we expect this demand to continue. The Board believes that the Company's portfolio continues to provide attractive revenues for a number of reasons:
· Highly-diversified, long-term portfolio of approximately 19,000 units across 400 assets with a low default risk
· Predictable revenue with upward-only rental increases, of which 70% of the portfolio ground rent income is index-linked, predominantly to the Retail Prices Index ("RPI")
· Long-term income with weighted average lease duration of 345 years
· 43% of the portfolio ground rent income is due to be reviewed over the next six years (from the most recent half-year report as at 31 March 2019). Assuming future RPI inflation of 2.5% per annum, ground rent income should increase by approximately 16% over the period, or an annualised figure matching that of RPI at 2.5%
The Board believes the principal reason for the Company's share price rating is uncertainty relating to leasehold reform. The Manager and Board are therefore taking steps to ensure that our shareholders' interests are fairly represented in this reform process which is outlined further below.
Ground rents sector update
Leasehold reform update
The review of the leasehold sector has focused on modernising the leasehold system to improve consumer protections in ground rents and more broadly in areas such as tenant rights, service charges and health and safety. Schroders and the Company welcome reform that delivers a more equitable, transparent and better service for homeowners. Institutional landlords with significant ground rents entitlements have the financial incentive, expertise and resource required to input into the reform process on aspects including risk, governance and health and safety oversight.
The Manager is engaging with the Ministry of Housing, Communities and Local Government ("MHCLG"), the Law Commission and other stakeholders regarding potential reform of the leasehold sector. The proposed reforms include a ban on the sale of leasehold houses and restricting future ground rents on apartments to zero (with some limited exemptions). The government and Law Commission have, at various times, emphasised that any potential legislative reform will be subject to both economic impact assessments and a requirement that, if required, 'fair' or 'sufficient' compensation be paid to landlords.
The Company and Manager's commitment to being a best-in-class operator in the sector is reflected in our commitment to the Public Pledge for Leaseholders (the "Pledge"). The Pledge was published by MHCLG in March 2019 and signed by a large cross section of freeholders, housebuilders and developers, including the Company. Both the Board and the Manager believe that the Pledge is an important step towards positive and transparent change in the residential leasehold sector and reflects the desire of the wider professional investor community to bring about meaningful, sensible and well-thought-out reform. The Pledge is published in full on the MHCLG website:
www.gov.uk/government/publications/leaseholder-pledge/public-pledge-for-leaseholders
Portfolio exposure to leasehold reform
The final outcome of leasehold reform, and therefore its potential impact on the Company, is uncertain. Greater clarity is not expected until draft legislation is published in 2020. The extent of any negative impact on the Company may be mitigated by the following:
· 96% of the Company's ground rent income reviews are index-linked, fixed, flat (no review) or double less frequently than every 20 years and are therefore not deemed 'onerous' by the review. Of the remaining 4%, a de minimis proportion (i.e. less than 0.1% of portfolio ground rent income) doubles in perpetuity
· The Company proactively introduced its Asset Management Plan in 2017 to engage with all residential leaseholders with a doubling ground rent, regardless of review cycle (from 10 to 50 years). The Company offered such leaseholders the opportunity to convert that review mechanism to the lesser of doubling or RPI inflation, while retaining their existing review cycle. The Pledge made this approach industry standard
· The portfolio median ground rent is £250 per annum
· The Company has limited exposure to leasehold houses which generate 11% of total ground rent income and where the median ground rent is £110 per annum
A more detailed overview of the portfolio as at 31 March 2019 is included in the half-year report published on 28 June 2019.
Beetham Tower, Manchester
Beetham Tower in Manchester (the "Building") has been part of the Company's strategy review due to ongoing litigation expenses which are negatively impacting returns. The freehold interest of the Building is owned by the Company's wholly-owned subsidiary, North West Ground Rents Limited ("NWGR"), and NWGR is liable for repairs and damages following the liquidation of the contractor, Carillion Construction Limited ("Carillion"). NWGR continues to pursue Carillion's insurers and sub-contractors under collateral warranties. The freehold interest of the Building has been written down to £100,000 in NWGR's accounts, but costs relating to the litigation, totalling £1.1 million, were expensed over the recent half-year reporting period to 31 March 2019. NWGR is reliant on the financial support of the Company (as its parent) to finance legal action, and any decision on future funding requests will have regard to the outcome of legal mediation planned for late 2019 and the prospects for recovering related expenses. Apart from the finance provided by its parent company formally documented under a loan agreement, NWGR has no external third-party liabilities other than expenses incurred in the normal course of trading and is ring-fenced from the Company's wider group.
Further detail on the background to the Building is included in the Company's half-year report published on 28 June 2019.
The Board and Manager continue to believe that seeking resolution to the Building's litigation remains in shareholders' and other stakeholders' best interests. This is based on the potential value to be recovered, although the outcome remains highly uncertain.
These litigation expenses were the principal reason for the reduced dividend cover of 63% over the half-year reporting period to 31 March 2019 (H1 2018: 83%). Dividend cover over the same period excluding these expenses was 94% (H1 2018: 88%).
Corporate Governance
As announced on 11 April 2019, Simon Wombwell will step down as a non-executive director of the Company no later than 30 September 2019. We are pleased that Bill Holland has agreed to join the Board as his replacement as an independent non-executive director and Chairman of the Audit Committee, with effect from 1 September 2019. Bill will bring significant expertise as a former partner of KPMG's real estate practice and KPMG's former representative to the British Property Federation's Finance Committee.
The directors will continue to take appropriate measures to ensure that the Company complies with the UK Code on Corporate Governance to the appropriate extent, taking into account the size of the Company and its nature of business.
Outcome of the review of the strategy and dividend policy
The following is the summary of the Board's strategy review:
· The Board and Manager will continue to engage with government, the Law Commission and other stakeholders regarding reform of the leasehold sector and building safety
· The Board believes the investment objective and policy remains differentiated and relevant. While the government review of the residential leasehold sector is ongoing, the Company is assessing other complementary assets that generate long-term, secure and inflation-protected income
· The Company, as an institutional landlord, has the expertise, resource and experience needed to provide the required risk, governance and health and safety oversight
· The Board has decided to maintain the current dividend policy of paying 3.96 pence per share per annum, with the level kept under review on a periodic basis. While asset-specific expenses, including Beetham Tower in Manchester will continue to negatively impact dividend cover in the near term, the Manager is focused on delivering asset management and financing initiatives to increase net income
· To bring the Company in line with established practice in the sector, the Board intends to distribute the next interim dividend for the period from 1 July 2019 to 30 September 2019 during November 2019
Contacts
Schroder Real Estate Investment Management Limited
James Agar / Chris Leek
020 7658 6000
N+1 Singer (Broker)
James Maxwell / Ben Farrow
020 7496 3000
Tavistock (Media)
James Whitmore / Jeremy Carey
020 7920 3150
Appleby Securities (Channel Islands) Limited (Sponsor)
Andrew Weaver / Zim Ceko
01481 755 600
