Buying Real Estate Investors (LON:RLE)

Where is the downside?

I added Real Estate Investors to my trading portfolio with the proceeds from the Record sale. Thanks to Zabeel Cap who covered the stock in Liquidations: Watchlist #3

Real Estate Investors is being wound down and owns mixed use commercial property located in the Midlands with a gross value of £124.6 million. It also carries £32.3 million of net debt and EPRA NTA was 51.3 pence at 31 December 2024 compared to a current share price of 29.5 pence.

At the end of January 2024, the Real Estate Investors board announced its intention to sell the company’s property portfolio over the following three years. The 2024 Annual Report published last week says that this target remains on track which would imply completion within two years. For the sake of assessing a downside scenario, I will assume the process takes three years from now.

Over the past four years, management has disposed of £75 million of property in total and achieved a premium to prevailing values in each and every year. The weighted average uplift achieved is 6.5%.

Portfolio occupancy dipped during the pandemic and has not recovered since. It stood at just 82% at the end of 2024 and to address this risk, I assume that the remaining portfolio is sold for 82% of its current gross value which equates to £102 million.

Management included the following statement in the 2024 Annual Report which I think is worth noting.

“The consensus in today’s market is that valuations have now broadly bottomed out and that investor confidence is returning.”

Of course, another step up in interest rates would shatter such optimism and drive a further decline in property values, and this prospect is not out of the question in the current geopolitical climate. However, I think that my above downside assumption covers this outcome, and my view is that we have likely seen a peak in rates for at least a couple of years given receding inflation.

Another factor which gives me confidence in the ability of management to achieve a satisfactory outcome is that the CEO holds over 10% of the company. In addition, both he and the finance director have bought a combined £300 thousand worth of shares on market in the past month. Finally, a short term incentive plan is in place which only rewards the executive team if the sell down occurs by the end of 2026 at above the current share price.

While the portfolio is being run down, the company continues to make modest profits supplementing total shareholder return (TSR). Under my three year wind down scenario, I estimate that after tax profits will total £3 million.

So, after accounting for all of the above I reckon that net proceeds to shareholders would be £67 million under a pessimistic case compared to a current market cap of £51 million. This represents a 30% return over three years (remember, if it takes this long there is no bonus for executives) or just over 9% per year.

On the other hand, if management sells the remaining property at current book value then net proceeds would exceed £89 million and the total return would be 74%. If this was achieved within two years then the IRR would be more than 30%.

Even better outcomes are possible under other reasonable assumptions. For example, if we assume that valuations have indeed bottomed and improve from here and/or property continues to sell at a premium to book. Management is also exploring an entire portfolio sale which could further accelerate returns.

I disposed of Record because I became impatient waiting for inflows to pick up. That stock has a dividend yield of more than 8% and greater potential upside than Real Estate Investors due to its capital free growth opportunities and operating leverage. However, while Record’s currency management niche has so far protected it, the passive revolution demonstrates that fund management businesses are fragile by nature. In contrast, I struggle to imagine a downside outcome with Real Estate Investors and an expected 20% annualised return, being the midpoint of my scenario analysis, is more than satisfactory.