Real Estate Credit Investments Limited (LON:RECI) is the topic of conversation when Hardman & Co’s Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.
Q1: Mark, we’re talking about your recent report on Real Estate Credit Investments but before we do, it sits behind a disclaimer. Can you just explain for us why that’s there?
A1: It’s a very standard disclaimer and nothing to worry about. In essence, for regulatory reasons, there are some countries, like the US, where the report should not be read. It’s not seen as being a simple asset class, and the report should be looked at by professional and qualified investors. That’s, as I say, a very standard disclaimer and nothing to worry about.
Q2: Now, your recent report was called ‘FY’26 Results: High Yield, Clear Path to Dividend Cover’, what can you tell us about the report?
A2: Looking at the results, the first key message is really around the dividend. Firstly, that dividend of 3p a quarter, so 12p a year, continues to be paid, as it has been for several years. That’s generating a dividend yield of around 10%, a very good dividend yield. It was uncovered in the last financial year, but there are clear paths for the cover to be re-established in due course, and, in the meantime, the Board appears very committed to maintaining the payout at the current level.
The second message from the results was that credit remains very good, with 92% of the portfolio performing and clear strategies to manage problem and defaulting assets.
Thirdly, whilst leverage has increased, it is still conservative in absolute and relative terms.
Q3: What are the options for RECI to reach dividend cover?
A3: It’s a very important issue for investors and we see three distinct paths to re-establishing dividend cover.
Firstly, normalising the fair-value losses and gains to the medium-term average level. That alone would see the EPS rise to around 11p, that’s nearly covering the dividend alone. Inter alia, in the last financial year, we saw equity participation loan losses and write-downs, which have not been the medium-term experience of the company.
Secondly, new investments are at higher margins, and the book’s short duration means that higher income can be generated on these new loans relatively quickly. Now, the company gave a possible scenario analysis, and the reinvestment of maturing loans at higher rates in that scenario, if it was realised, would add a further 1.6p to the EPS.
Thirdly, there’s leverage. Now, the current financial year will see the full-period benefit of the higher leverage that was taken through the course of the last financial year. Additionally, should RECI return to its pre-pandemic rating of being at a premium to its NAV, we expect equity issuance to fund economies of scale, generating volume growth. As a statement of intent, we build such an issue into the end of our second-year forecast, so any earlier issuance on that would see a likely upgrade to EPS.
So, normalising losses to a medium-term average, the reinvestment of loans at a higher rate than they’re currently at, and leverage are all potential levers to get back to dividend cover.
Q4: Can you touch on Real Estate Credit Investments’ credit management, a key feature for any real estate finance provider?
A4: As you say, credit is really important for any finance provider. The macro environment may be challenging, but it’s really important to recognise that RECI is focused. It’s in specific niches, so market headlines really are not the key driver of its credit performance.
Investors should focus on the low loss in the event of default, as well as the probability of default. Now, in previous reports, we reviewed in detail how lending is assessed, the strong security taken, the close monitoring and problem-account management, all of which serve to reduce the probability of loss and the loss in the event of default.
RECI has published more detail in its risk-rating analysis, which showed 92% of the portfolio is fully performing and not even on a watch list for potential underperformance. The residual 8% of the portfolio, which accounts for about 10% of NAV, is primarily in the category of defaulted, but with no further loss to NAV expected.
With its largest problem account, there are advanced discussions with tenants, which will help ongoing payments, but exit from that loan is looking a bit challenging at the moment. And, as I mentioned, no further losses are expected from this exposure.
Q5: Were there any other issues in the results?
A5: Our report reviewed three relatively minor issues.
Firstly, we looked at RECI’s leverage, finding it appropriate, long-term, conservative and much lower than most other real estate finance providers.
Secondly, we looked at cash flows, noting the capitalisation of interest, which is a very common practice, especially for development finance.
Finally, we reconciled various measures, such as sector and geography disclosure, where statutory reporting is not consistent with how the management looks at the business and, therefore, how it reports it in some other disclosures.
None of them are particularly critical. As I say, leverage is contained and very conservative.
Q6: As with any investing, there are always risks. Can you tell me about the risks here?
A6: You’re absolutely right, there are always risks. The risks of a downturn, that would be clear to see in credit. Risks from higher interest rates, post the Iran war situation, lower disposable incomes, falling property prices, residential and commercial, sometimes compounded by distressed sellers of assets.
There are rising social tensions, and governments are facing large fiscal deficits and central banks inflationary pressures. All of those have been risks that we’ve considered in detail in previous reports.
The key thing is really to focus on how RECI assesses risk, closely monitors its clients and manages problem accounts, all of which reduce the probability of default and the loss in the event of default.
