The strong returns evident in LXi REIT's (LON:LXIL) (LXi’s) interim results continued through Q322, well above the company’s target of at least 8%, supported by swift and accretive capital deployment.
In this article, we review LXi’s strategy and the prospects for continued growth based on inflation-indexed rent uplifts and accretive portfolio acquisitions, reflected in our updated forecasts.
Income and capital driven returns
Based on LXi’s unaudited 31 December 2021 (Q322) NAV (EPRA NTA) per share estimate of 139.5p (Q2: 135.5p), including DPS paid the quarterly NAV total return was 4.0%, bringing the year-to-date total to 14.6%.
LXi is well on track to meet its FY22 DPS target of 6.0p and is targeting a 5% increase to 6.3p for FY23. The proceeds of the upscaled, oversubscribed £250m (gross) equity raise that closed on 9 February are already fully deployed at an accretive blended net initial yield (NIY) of c 5.2% (current portfolio 4.5%), with additional assets in solicitors’ hands.
Each acquisition is fully let with a strong tenant covenant on long-term, fixed uplift leases, underpinned by affordable rents. Our revised forecasts reflect further strong debt-funded asset growth as within LXi’s 30% LTV target. Our cash EPS forecasts are lowered but with no interruption to expected fully covered DPS growth.
Diversified, inflation protected, long income
With 96% of rents subject to fixed or index-linked, upward-only increases, LXi offers significant income protection against inflation. A 22-year unexpired lease term and strong tenants add to income visibility and should mitigate cyclical volatility in capital values. A multi-sector approach differentiates it from many specialist peers, spreads risks and broadens its universe of investment opportunities.
The experienced investment advisor continues to demonstrate an ability to source attractively priced assets to enhance income and net asset value—often off-market, smaller lot size, sale and leaseback transactions and forward-funded development schemes. Capital recycling provides firm evidence of this, generating capital gains and allowing redeployment into accretive acquisitions at higher yields.
Valuation: dividend growth, fully covered
Capital growth and targeted dividend growth has seen LXi’s prospective dividend yield (FY23e) widen to an attractive 4.3% while its premium to (Q322) NAV has narrowed to c 6% from c 18% in September 2021. The outlook for further inflation protected DPS growth is strong, well covered by EPRA earnings and fully covered by cash earnings as acquisitions make their full impact.
Share price performance
Business description
LXi REIT is an externally managed UK REIT investing in high-quality, smaller lot size (£5–15m) assets, let on long index-linked leases to strong financial covenants across a range of sectors with defensive characteristics. It aims to provide a secure and growing income with capital growth over the medium term, with a total return of at least 8% pa.
Strong accretive growth continuing
We expect a continuation of strong growth at LXi, driven by rental uplifts and accretive, largely off-market acquisitions, including attractively priced forward funded developments. LXi’s portfolio benefits from defensive and resilient characteristics including diversification across a range of structurally supported sub-sectors, with a focus on non-discretionary uses, let to a broad spread of high-quality and well-capitalized tenants.
Following swift deployment of the proceeds of the £250m (gross) of equity raised in early February, we expect an additional £100m of debt-funded acquisitions before September 2022 although we estimate that LXi could invest twice this amount without breaching its 30% loan to value ratio (LTV) target.
While the uncertainties of the pandemic have eased and restrictions have been lifted, economic uncertainty remains, more recently accentuated by international tensions. Despite the potential negative impact on economic growth, the continuing increase in commodity and fuel prices seems likely to sustain inflationary pressures.
In this environment, LXi is well placed to offer inflation protected returns, with 96% of portfolio rent reviews linked to UK inflation or containing fixed uplifts. Although inflation is currently above the average c 4% caps that apply to index-linked rental uplifts, a substantial spread remains above funding costs. Fully let assets on long leases at affordable rents provide significant income visibility and, provided those tenants selected by LXi perform as it expects, protection from the occupancy risk that may face the mainstream commercial property market should the economy weaken.
Income visibility and inflation protection
LXi has a long weighted average unexpired lease term (WAULT) of 22 years, while index-linked leases (mostly capped and collared) and fixed uplift leases provide significant income protection against inflation.
Conversely, fixed rents and rent collars (minimum uplifts to indexed rents) ensure continuing rent growth if inflation falls to low levels. The 12-month rate of CPI increase was 5.5% in February 2022, the highest rate of increase since March 1992, while the 7.1% rate of RPI increase was the highest since March 1991. The Bank of England continues to expect a moderation in inflation as commodity prices stabilize, supply shortages ease and global demand rebalances, but this is far from assured. International tensions have seen oil and commodity prices increase further.
Of the 96% of rents that were indexed or fixed at end-FY21, 75% were indexed to inflation (56% indexed to RPI and 19% indexed to the CPI). The 21% of rents that provided fixed uplifts did so at an average of 2.3% pa. Rent reviews completed during H122 reflected average growth of 2.9% pa, but with 62% of rents reviewed at five-yearly intervals, higher levels of inflation will increasingly be reflected in passing rents.
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