Amid the avalanche of results during this busy reporting period, you may have missed a bullish set of numbers from PRS Reit (PRSR). The company offers insight into how Reits grow. Or fail to.
PRS Reit is a buy-to-let landlord. Except not in the regular sense, because it buys homes en masse from housebuilders and lets them out. And, crucially, it does this before construction has begun, thus funding the development of new rental homes rather than buying existing homes to turn into rental properties, a cornerstone of its investment case.
Housebuilders like selling to PRS Reit when high interest rates mean the market for private buyers is weak. On top of that, residential rents are increasing at their fastest pace on record thanks to a strange mix of low supply, high wage growth, landlords passing on the cost of interest rates, renters’ inability to buy, and high immigration. In short, business is booming.
The numbers speak for themselves. In the six months to the end of 2023, PRS Reit’s net rental income jumped 17 per cent. That is because it has snapped up more homes, growing its net asset value (NAV), and because it has been able to raise rents for existing tenants.
It is a stellar performance, but what happens now? A few years ago, PRS Reit set a target to build around 5,600 homes and raised money to do so. After it builds out its current pipeline, it will hit that target, and it doesn’t have cash in the pot to build more. The company knows this and told Investors’ Chronicle it is speaking to its shareholders about its next move.
It could raise equity, but that will be a tough sell when the stock trades at a steep discount to NAV. Or it could simply sit on its portfolio and raise rents. After all, that’s what Primary Health Properties (PHP) is doing, having told us it would not consider an equity raise because of its discount to NAV.
However, for PRS investors, that prospect might not be particularly appetising. Doing so means low (if stable) earnings increases and low (if consistent) dividend growth. That is fine for businesses such as PHP and its rival Assura (AGR), which market themselves on the boredom dividend of long leases to the NHS that contain contractual rent rises. However, PRS Reit promised investors a 6 per cent dividend yield and a 10 per cent shareholder return in its IPO prospectus. That requires high growth.
In short, it must boost its net rental income. However, Savills predicts residential rent growth will normalise to 3.5 per cent by 2025 and 2 per cent by 2028 because renters cannot afford record-breaking rent rises forever. Indeed, many cannot afford it now.
So, to keep growth high, PRS Reit needs to keep building new rental stock. That means it needs to either raise equity at a discount, take on high-interest-rate debt, sell old assets in a downturn to fund new ones, or merge with another Reit. All those solutions come with problems.
If this salty pickle sounds familiar, it is because it is the one all Reits are in. While they wait for interest rates to fall, a process that could take years, they must figure out how to grow. PRS Reit is in a better place than many, but it is far from perfect.
This article has been amended to clarify the nature of PRS Reit’s discussions with shareholders.