Directors Buy Into Their Property Developer Shares.

The Penny Sleuth was pounding the streets of London yesterday first to visit a fascinating and potentially very rewarding company in the field of medicine that could become a subject for my Red Hot Penny Shares newsletter. And his second visit was to a company that, I suggested to Chief Executive Philip Leech, finds itself in the eye of the storm.

This was Terrace Hill an AIM-listed property developer that has seen its share price tumble from a 94p to 34p in the last twelve months, at which level it is valued at £72m, little more than half the £133m net asset value figure recorded at the end of April.

61% of Terrace Hill’s shares are owned by founder Robert Adair who, in a neat display of diversification, also owns 53% of Melrose Resources, a stake worth £165m. So he is placed to take a rather more relaxed view of the credit crunch than the rest of us and in fact, along with finance director Jon Austen he has been a buyer of Terrace Hill shares this month. Should we follow their example?

Terrace Hill was founded created in 2002 by the merger of Adair’s Westview Group and the AIM-listed CapitalTech, a company that sounds suspiciously like a dot-com failure but was in fact the owner of a portfolio of residential properties originally assembled to benefit from the short-lived Business Expansion Scheme.

Away from big trouble

Terrace Hill now owns two hundred and fifty-one flats in Scotland and has a 49% stake in a portfolio of 1,715 properties throughout England, typically in suburban locations and, Leech assured me, away from the city centre sites where buy-to-let landlords are suffering so severely.

This portfolio was valued at £292m in April, equivalent to £154,000 per flat, and although values have undoubtedly fallen since, Leech pointed out that prices have now dropped below that which it would cost to rebuild them; and with people now happy to rent rather than buy the properties are well let, at an average rental that rose by 7% last year.

Leech believes that the residential market is likely to pick up before the commercial market, and believes, or at least hopes, that this could happen reasonably quickly. The banks and building societies should now start lending again, and the Bank of England’s official interest rate should follow the downward course of inflation over the next twelve months, not of course that there is any guarantee that this will feed through to high street mortgage rates.

This is of relevance not only to Terrace Hill’s residential property portfolio, but also to its house-building division Clansman Homes which, as you can probably guess, is based in Scotland where it has a number of sites that were formerly brickworks within commuting distance to the south of Glasgow.

Here Terrace Hill has simply stopped work. Clansman has a land bank of 1,400 plots and the plan was to build one hundred homes this year. But with market conditions as they are, Clansman has simply downed tools, and is concentrating instead on progressing planning applications for its sites. It has just seven homes to sell, four of which are former show homes.

Commercial woes are deep

But the largest part of Terrace Hill’s portfolio is accounted for by its commercial properties. It also owns three completed properties in Sheffield, Bristol and Hampton, worth £17m, but the emphasis is on development rather than investment.

It owns twenty-five office development sites principally in the South East and the North East, valued at £1.14bn and ten retail development sites, valued at £117m. About half of these have committed development schemes, but for the rest Terrace Hill can wait.

The properties are at various stages of development and although Terrace Hill has found its bankers demanding stiffer terms for roll-over of loans it has not so far encountered any difficulties either on the financing side or with its tenants and development partners. ‘Contrary to what you read in the papers,’ Leech assured me, ‘there still are lenders and they are still doing business.’

As broker Altium Securities has argued it is hard to accurately value development sites, given the uncertainties relating to building costs, lettings and future property values. On the other hand it is through the development process that value can be added, and a good example of this was provided by Terrace Hill’s Queens Wharf property in Hammersmith, bought for £17m in December of last year but sold on for £30.7m just three months later after the planning authority had approved a change of use from commercial to residential.

This was a good deal under any circumstances but never more so than today when cash is king. Thanks to this Terrace Hill has net bank debt of £73m, equivalent to 55% of the April figure for net assets, but the other important ratio, that of the loans to the value of properties was 34% or 56% if including Terrace Hill’s involvement in joint ventures.

As Leech admitted there are times when you should have masses of gearing and times when you should have none, and while he would love to be in the latter position the current situation is comfortable especially as loans are secured against individual developments rather than against the assets of the group.

So it is really a question of weathering the storm and Leech thinks that sentiment towards the property sector could yet get worse. While good quality assets are now reasonable value he believes that gloomy headlines could be made later this year when the banks bite the bullet on some of their low quality property loans and jettison them at any price.

So although Terrace Hill’s share price today stands at a discount of some 40% to broker Altium’s conservatively struck estimation of net asset value, it may be a bit early to be looking for a recovery.

Regards,

Tom Bulford
for The Penny Sleuth

P.P.S. If you want to follow the insights of a small company investor, and uncover the hidden gems of the stock market, find out more about The Penny Sleuth by clicking here.

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Directors Buy Into Their Property Developer Shares.

In The Eye Of The Storm