UK value is elusive quarry for new REIT’s deal-hunting duo

The joint CEOs of newly converted REIT Hansteen are having to widen their search and bide their time in their quest to invest a £500m war chest in industrial property bargains, writes Jane Roberts

After the near 10% bounce in UK property values since August, finding assets that are not overpriced is the biggest challenge for every investor with capital Hansteen, the industrial specialist and newest UK REIT, is in exactly this position. Having raised £260m of equity last summer, £200m from the public market and £60m for a private Jersey property unit trust, joint chief executives Morgan Jones and Ian Watson know vendors can see them coming.

Noble Group property analyst Michael Birt started covering the four-year-old, expanded Hansteen after the company moved up from AIM to a full listing last October. “With debt, Hansteen has £500m to spend and there’s just not the stock out there,” Birt says. “The company does need to do a deal and the danger is it might overpay – the market is changing very quickly.”

In this environment it pays to stay flexible. Last July, when existing shareholders took up two-thirds of the new public equity issued by Hansteen and the rest was placed, the company said its war chest was mainly for UK acquisitions. But with direct market prices soaring, it looks as if Hansteen’s first big deal will be in Germany, where the HBI portfolio is poised to drop into its lap after the front runner to buy it, AIM-listed Sirius, pulled out a month ago.

“This time last year we had a €450m-500m portfolio spread across western Europe, in Germany, Holland, Belgium and France,” says Hansteen’s Jones. “It was held at a loan-to-value ratio of about 50% and we had high income from it, at low interest rates, so it was quite a stable position. But we didn’t have any capital to take advantage and to grow, unless we really geared up – which was not what we wanted to do. “So we had the opportunity to raise money and raised £200m on the stock market. Certainly at the time, the opportu-nities all appeared to be in the UK and that’s what we promoted the fund raising for.”

Wrong-footed by market shift

But Hansteen was wrong-footed. No sooner had it raised the capital than the market significantly shifted last August and September. Jones continues: “Suddenly the institutions and unit-linked funds responsi-ble for the piles of sales brochures on our desks from May pulled back and said they weren’t selling anymore.

“The public companies like Brixton, Segro and Workspace had all sorted themselves out in one way or another, so they weren’t selling and the big bank beasts hadn’t yet started to push things out onto the market, so the whole thing froze up. We  had the equity in our hands but the UK deals had disappeared.”

As a Jersey property unit trust, Hansteen UK Industrial PUT is “constrained” and will stick to its original strategy, which is to buy in the UK. But it focuses on smaller industrial assets, under £15m. Hansteen contributed £30m, so it has £90m of equity. Watson says the main company will be flexible, so has been looking at Continental corporate and portfolio deals, such as the HBI portfolio, but it will continue to seek value in the UK.

“We are confident that we will find it in time, but probably not in the straightforward way that we had hoped for last May, when there seemed to be, as Morgan said, a flood of direct property being sold by forced sellers; unit-linked funds and the straight-ened plcs. As that’s all changed, the value in the UK market will emerge in more complex situations. But we think it will be there.”

One way to gain UK property exposure is via the indirect market, where assets may be cheaper because the vehicles that own them are trading at a discount. Jones says Hansteen has “poked its nose” into two companies, buying stakes in Warner Estates which in turn bought Ashtenne, Jones’ and – Watson’s previous company, in 2005 – and Kenmore European Industrial Fund (KEIF).

“Both looked as if they were lacking in direction, at least at the time. The share price had fallen and with a relatively small stake we could get a seat at the table if anything was going to happen with those property companies,” Jones says. Hansteen bought into both companies for small sums; the Warner foothold cost £3m and the KEIF stake, half in shares, cost £6m.

Watson’s and Jones’ interest in Warner is in the Ashtenne Industrial Fund, managed by Warner and Aviva Investors, and its Radial distribution joint venture. Warner hired industrial property veteran John Heawood to run Ashtenne last year. He sold 37 assets for £90m by the end of 2009, but often at low prices, reflecting discounts to valuations before the market bounced.

Investors have suffered as the fund has cut distributions, but stumped up £45m on 2 October to push through a four-year refinancing of a £364m loan with RBS and Lloyds; but the fund is still highly geared. Meanwhile, Warner Estates is at the mercy of its banks and has been renegotiating its three debt facilities with RBS, Lloyds and Barclays for more than six months. One facility is overdue and is being rolled periodically, while the company stated in its last March full-year and 30 September 2009 half-year results that covenants on the other two would not be met if they were tested.

Hansteen acquired 18.5% of Warner last August from Jack Petchey’s Trefick invest-ment company, using shares, so Petchey at the very least sees potential upside from Hansteen’s involvement. “We bought it as a strategic stake and haven’t had hostile intent,” says Watson. “We see a situation that isn’t sustainable; there will be change, and our instincts and experience tell us that in the course of that change there may be opportunities that arise and we’ll be better placed to act as substantial shareholders.”

Kenmore fund in the frame

KEIF, meanwhile, is a functioning business, but was potentially in trouble last November when Kenmore Property Group, parent of KEIF’s external fund manager, Kenmore Financial Services, went into administration. Also, the fund itself is highly-geared. On 25 November, Hansteen revealed that it had bought a 12% stake for 41p per share and was considering making an offer for the remaining shares at the same price.

That price represented a 24% discount  to KEIF’s September NAV of 47p. Yet since then KEIF’s share price has not moved above Hansteen’s indicative offer, despite opportunistic investor Joe Lewis buying a 7.5% stake and backing a management buyout this month, led by Kenmore’s Rob Brook, of the existing external management.

So far, KEIF has not given Hansteen access to carry out due diligence to make a formal bid. Watson says: “The questions for KEIF’s shareholders are: do they want to stay externally managed, with the existing management?; how will they cope with the refinancing coming up with RBS in the autumn?; will they raise new equity for the business?; and are existing shareholders happy to support that?”

Jones and Watson have worked together for 25 years and frequently say they are “like an old married couple”. However, all their experience couldn’t prevent Hansteen from taking a €57.6m hit on a currency hedge against the euro in 2008, when the currency strengthened rapidly against the pound. The position was closed out to avoid further unquantifiable cash commitments.

“Our capital is now broadly 50% sterling and 50% euro and we are happy to leave that scenario un-hedged,” Jones says. “If our capital became 100% euro again we might have to consider hedging part. I think our investors recognise that we are pan-Europe-an and that carries a slight risk.” The majority of their investors also invested in Ashtenne, and Watson says he and Jones have met them at least once since last summer’s fund raising.

“Undoubtedly, like us, they are disappoint-ed that we haven’t picked up fantastic bargains in the UK in the past three months,” Watson says. “But faced with over- paying just to invest the money or holding on and getting value, I think they would definitely want us to hold on for value. There is some pressure [to invest], but our job is to resist it until we can find the value. “We will come under a bit more scrutiny if we don’t spend the money in another 12 months, or at least some of it. But for now our investors are saying: ‘We don’t want you to spend it for the sake of spending it’.”

Failure of Sirius deal lines up German buy for Hansteen

300m. listed German investor Sirius fell through last month. GPT Halverton, the European fund manager that was bought in December by Internos, is advising HBI Sirius said discussions to buy the portfolio ended after carrying out “a substantial amount” of due diligence and that it had written off about €1m in fees. The portfolio is being offered with stapled debt and if the deal goes ahead, Hansteen’s equity commitment is likely to be about €80m. Hansteen co-CEO Morgan Jones says: “We are looking at a material deal on the Continent, which has some way to go and we can’t comment on it.”