Green Buildings, Brownfield Price

We caught up with Árima during their London roadshow. This Madrid green office REIT’s shares have held up somewhat better than the STOXX Real Estate Index, and one can see why. Despite the fact that Arima’s buildings and projects are classic “green premium” rentals, its market cap currently implies a yield of over 7%.

Botanic case study image
Source: Company Presentation

In the office world, life is rapidly becoming all about having the right environmental credentials, as pointed out by the Urban Land Institute in this recent FT Article. Árima’s portfolio is richly adorned with high-grade environmental/wellness certifications, and we now have some numbers on the positive impact of their projects.

CEO Luis López de Herrera-Oria’s Team has a long history of providing the Madrileño business community with the Grade A, environmentally certified space the city lacks. At their previous start-up, Axiare (16% CAGR during their tenure), they were among the very first Spanish property practitioners to achieve LEED Platinum certification.

At Árima, which they listed (with significant skin-in-the game) in 2018, all the existing whole buildings owned, including the 50% of the portfolio under refurbishment, have achieved or are aiming for the highest levels of recognition from the various rating bodies, with clear benefits for chargeable rents. The recently completed and let Habana building demonstrated premiumisation to wonderful effect; it now houses an international law firm that moved from hyper-central Paseo de la Castellana, paying rent which is far above what the building was commanding when Árima bought it.

As well as certificational excellence, Árima’s latest development to be completed, Botanic, has some comparative numbers to excite our inner planet-savers. Retaining the original structure, which Árima does with the vast majority of its projects, achieved embodied carbon savings equivalent to planting 6,000 trees, and the improvements made brought certified CO2 annual operational emissions per m2 down from 69kg to 13.4kg! Impact investment of the highest order, to say the least.

H1 22 brought ringing validations of the Company’s strategy of creating alpha by sourcing good-value office buildings and sustainably transforming them into highly desirable, low carbon footprint space.

The Habana building’s contracted rent represents a YOC (yield on completion) of 6.4%, compared to the average yield of 3.5% that prime CBD space has been changing hands for. Assuming a plausible 35% LTV, that’s a pretty good return on equity in anyone’s book. In addition, the rental income was 8% more than the building’s Dec 2021 estimated rental value, thus endorsing Árima’s internal rental income projections (more on this below). Árima also entered into negotiations with two single tenants for the Botanic building, which builders Construcía described in a Linkedin post as “one of the most sustainable buildings in Madrid”.

The third major event of the first six months of this year was the securing of additional space for Árima’s Pradillo project, which is a prime example of the complex, multi-vendor, off-market transactions that Luis Lopez’s team excel at. The building’s refurbishment, which will take place over the next two years, is expected to deliver a YOC in excess of 7%. Interesting to note, in the context of Alpha generation, how Árima’s total return has outperformed its European office REIT peer group, despite its current 8.5% LTV, and the fact that its refurbishment projects have only just started coming through.

Source: Company Corporate Presentation
Source: Company Corporate Presentation

Árima’s projected rental income, when current refurbishments are completed (expected year-end ‘24), is around €21m. Taking current market cap and projected debt, that represents an implied yield of 7.3% - higher than prime Madrid office space yields rose to during the GFC.

Madrid prime cap rates peaked in 2009 at 6.5%, which means that, even if they go back  to those levels (from the current 3.25%), Árima’s projected NAV would, arguably, still have some upside. That’s quite a safety net! Of course, rents can and do fall in times of economic distress, but Madrid is close to unique among major European cities in having office rents that are still below pre-GFC levels, and the vast majority of Árima’s rents are CPI-indexed. Again, this offers a degree of protection, as does the quality of Árima’s tenant base.

Also, let’s not forget that Árima’s current LTV is 8.5%, so spare firepower abounds, and a shake-out precipitated by rising rates (and/or environmental regulations/demands) is seen by management as an opportunity to secure new assets at attractive prices. Important also to mention, in the context of rising rates, that close to 80% of Árima’s debt is not due for re-financing before 2026, so higher rates would not give rise to cash-flow concerns.

Finally, worth reminding ourselves that, using current parameters, Actio estimates that Árima’s NAV per share could go to roughly double the current share price in a couple of years, and Luis’s team would still have about €100m to spend on new assets.

That projected €21m of rent, rising to, say €22m with a couple of years’ indexation (Árima’s rents are mostly CPI-linked), valued at a 22x “near-prime” multiple, takes us to a GAV of around €490m. Net debt at that point should be around €90m, so NAV per share would be €14, against the current share price of €7.25. Also, LTV would still be only around 18%, and the targeted level is 37%, hence the potential for further acquisitions and value creation without raising more capital. The 22x multiple is, of course, a crucial assumption, as are stable rents (NB mostly CPI-indexed) and building costs, but the current price does give significant wiggle room on all of those parameters.

NB – Actio may be working for the companies we write about, and we recommend you effect your own due diligence before making any investment decisions.

This is not an offer (or solicitation of an offer) to buy/sell the securities/instruments mentioned or an official  confirmation.  Unless indicated, these views are the author’s and may differ from those of Actio, its subcontractors, or others in the Firm.  We do not represent that the attached is accurate or complete and we may not update it.  Past performance is not indicative of future returns, and this document does not constitute, and should not be interpreted as investment advice. It is accordingly recommended that you should seek independent advise from a suitably qualified investment professional advisor before taking any decisions in relation to the investments detailed herein. No liability whatsoever is accepted by Actio or any of its respective directors, officers or employees for any loss, whether direct ore consequential, arising whether directly or indirectly as a result of the recipient acting on the contents of this document. If this e-mail includes any information on listed or unlisted securities, then we have categorized you as falling within the exemptions set out in the UK Financial Services and Markets Act 2000 Order 2001 and Order 2005 in particular at paragraph 14 (investment professionals), paragraph 21 (certified high net worth individuals), paragraph 22 (high net worth companies etc), paragraph 23 (certified sophisticated investors), 2005 Order Schedule 2, paragraph 1 (self certified high net worth individuals) and 3 (self-certified sophisticated investors), and any person outside the United Kingdom to whom this document may be lawfully sent; if this is not the case then please inform us immediately.

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Max Casini – 23 November 2022

Àrima Corporate presentation

Árima Contact Details

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