Aew Uk Reit Regulatory News (AEWU)

16 November 2022

AEW UK REIT PLC

Interim Report and Financial Statements

for the six months ended 30 September 2022

AEW UK REIT PLC ("AEW UK REIT" or the "Company"), which holds a diversified portfolio of 35 commercial investment properties throughout the UK, is pleased to publish its Interim Report and Financial Statements for the six months ended 30 September 2022.

Mark Burton, Chairman of AEW UK REIT, commented: "We are pleased with the robust performance of the Company during the period, which reported NAV total return of 4.35%, achieved against a backdrop of economic uncertainty. We believe that the Company is defensively positioned given its focus on value and having prudently fixed the cost of debt early in the period. The Investment Manager's unconstrained sector approach and its active management style also provide a strong basis for counter-cyclical performance. Given the market volatility, the Company's high cash weighting makes it very well-positioned to select assets from the increased number of investment opportunities that are expected to present in the near future which supports our focus of returning to full investment and to full cover of the dividend over the medium term."

Financial Highlights

Property Highlights

* See KPIs in the full Half-Yearly Report for definition of alternative performance measures.** See glossary in the full Half-Yearly Report for definition of alternative performance measures.1 The valuation figure is reconciled to the fair value under IFRS in note 11 in the full Half-Yearly Report.

Chairman's Statement

Overview

The Company reported a resilient NAV total return of 4.35% for the six-month period to 30 September 2022. Following a prolonged period of strong capital performance up to the end of June 2022, which saw the Company report a three-year annualised NAV total return of 17.7%, the value of the Company's assets fell marginally in the three months to September, reflecting broader pricing pressure in the UK commercial property market. This has been seen as a result of ongoing political and economic instability in the UK, where a sustained period of high inflation has been exacerbated by the sanctions-related energy crisis. With a backdrop of an uncertain political outlook, this has seen costs of borrowing increase rapidly since the start of 2022 and, after early valuation declines in prime assets lower down the yield spectrum, is now starting to impact across most asset classes.

As a result of this uncertainty, the shares of listed property companies have sold off almost indiscriminately over the period. The Company's own shares demonstrate this, having started the six-month period to 30 September trading at a discount to NAV of 0.68% and finished the period trading at a discount of 23.2%. This has led to a disappointing shareholder total return for the period of -18.5%, albeit the Company trades at the narrowest discount of its peer group in UK diversified REIT's. We hope that this, along with the Company's track record of outperformance and its robust positioning, will stand its shares in good stead once market sentiment recovers.

Current consensus forecasts show an expectation for the Bank of England base rate to peak at 4% in early 2023 and for it to remain at that level for more than a year. The Company took the prudent decision to complete a full refinancing of its loan in May 2022, leaving it defensively positioned to weather the current period of high interest rates. In May 2022, the Company was able to fix its cost of debt at 2.959% for the next five years, protecting it from the impact of rising interest rates on its cost of borrowing. There is also significant headroom on both the loan-to-value and debt yield covenants associated with the loan. Consequently, the outlook for the Company, from a debt financing perspective, is robust. We also believe that high yielding assets, such as those in the Company's portfolio, will be more resilient over the long term to the valuation impact of rising interest rates, albeit further near-term value decline is expected. With higher "starting" yields, the portfolio's current book values are closer to long term value fundamentals such as vacant possession values, alternative use values and replacement cost.

A particular performance highlight during the period was the sale of Eastpoint Business Park, Oxford, which completed during August 2022 for £29.0 million. The property was acquired in May 2015 for £8.2 million, providing a net initial yield of over 9%. The asset sale was realised following the culmination of a multi-year business plan, which included the signing of a 25-year lease in 2018 with specialist healthcare provider, Genesis Care. The lease provided for five-yearly compounded rental uplifts in line with RPI, which increased the asset's value by £2.0m. As a condition of this letting, the Investment Manager sought planning consent for change of use away from the asset's existing office use, setting a precedent for healthcare and life science use in the location. Since the signing of the existing lease, investor demand in the healthcare and life science sectors has increased considerably and this is reflected in the sale price, which crystallises significant profit. The asset delivered an IRR to the Company in excess of 22% during its hold period, with the sale price exceeding the valuation level immediately prior to the sale by 16%.

Another key sale during the period was the Company's asset at 225 Bath Street, Glasgow, for £9.3 million. The sale realises a long-term change of use strategy for the asset, for which contracts had been exchanged with a subsidiary company of IQ Student Accommodation in October 2020. Since that time, the purchaser achieved detailed planning consent for the redevelopment of a 527-unit student accommodation scheme at the site and the Investment Manager negotiated with tenants to bring the asset to vacancy. As such, the sale of the asset led to a reduction in the portfolio's vacancy level and will lead to a boost in earnings once capital from the sale is reinvested. The sale demonstrates the Investment Manager's ability to pursue an alternative use strategy due to weakened occupier market conditions in this location.

Assisted by these notable sales, the Company's office assets saw a total return of 24.0% during the period. The fact that these returns were achieved during a period when wider office sector performance was negative points to the effectiveness of the Company's investment strategy to drive counter-cyclical returns during periods of wider value decline due to its value investment fundamentals and active management style. The Investment Manager and the Board believe that the Company's ability to seek value opportunities unconstrained by sector is key to the maximisation of total return over the long term.

The sales of Glasgow and Oxford during the period also form an important step towards the portfolio's planned return to full cover of its dividend. Despite dividend cover since IPO being in excess of 90%, earnings have been reduced in recent quarters, primarily as a result of vacancy in these assets that was required in order to maximise their sale values to alternative use developers. Together, the assets had been producing an income yield of circa 1.0% and therefore reinvested proceeds from the sales of assets producing net initial yields between 6.75% and 10% will be significantly accretive to the Company's earnings in future periods.

The Company completed two purchases during the period. In June 2022, the Company acquired the 6.04 acre Railway Station Retail Park in Dewsbury for a price of £4.7 million. The purchase price reflects a low capital value of £82 psf and provides an attractive net initial yield of 9.4%. The park is fully let and located in an area of low supply with a low average passing rent of £8.28 psf. The Investment Manager believes this provides strong potential for rental growth. During August 2022, the Company completed the purchase of a high yielding leisure asset in Glasgow for a price of £2.6 million, reflecting a low capital value of £99 per sq. ft. and a net initial yield of 7.4%. The site contains a vacant plot of land which may be suitable for redevelopment over the medium term, subject to planning.

We believe that balancing the Company's investment rate against expected pipeline opportunities will be beneficial to our shareholders' total return. The Company currently benefits from a high cash weighting, leaving it advantageously positioned to select assets from the increased number of investment opportunities that are expected to present in the near future. The Investment Manager is currently analysing a pipeline of investment opportunities, including those assets that the Company had placed under exclusivity over the summer, albeit these are being re-evaluated against current pricing. The focus of the Company's investment strategy remains to return to full investment and to full cover of its dividend over the medium term.

Although the outlook from a capital markets perspective is one of increased volatility, we are not, at this point, seeing this reflected in the uptake by tenants of the portfolio's occupational space. Active asset management is a key driver of value and income resilience within AEWU and, during the period under review, the Investment Manager agreed terms with several key tenants to take space, the terms of which were agreed in line with the rental estimates of our expert independent valuer, Knight Frank. Several of these lettings have been in the portfolio's industrial assets, including the letting in Rotherham to Senior Architectural Systems Ltd which completed in September 2022. This letting will deliver a rental income to the Company 49% ahead of the level paid by the previous tenant and, in addition, income growth during the lease term is ensured by inflation-linked reviews. This activity highlights ongoing demand from industrial occupiers. AEWU's industrial holdings show an average passing rent of £3.37 per sq. ft. and are expected to continue to deliver growth over the long term from this low starting point.

Other key lettings during the period took place at Arrow Point, Shrewsbury, where a 10-year lease renewal was completed with Charlie's Stores at a level 46% higher than ERV. At Queen Square, Bristol, a renewal to Konica Minolta at £40 per sq. ft. set a new high rental tone for the building.

Financial Results

* see note 9 of the Financial Statements for the corresponding calculations. See the Investment Manager's Report for further explanation of performance in the period.

Awards

I am delighted that the Company's market leading performance and practices have been recognised in two awards gained during the period. The Company has once again been awarded by EPRA, the European Public Real Estate Association, a gold medal for its high standard of financial reporting and a silver medal for standards of sustainability reporting. Post period-end, the Company has won the Citywire investment trust award in the 'UK Property' category, an award given to the trust displaying the highest NAV returns over a three-year period. AEWU won this award in both 2021 and 2020 so we are very pleased to receive it for a third consecutive year. The Company has also been nominated for 'Best REIT' at the AJ Bell Shares Magazine awards, voted for by readers of the publication. We are delighted that these awards and nominations recognise the hard work and dedication that is put into running the Company by both my colleagues on the Board and the Company's Investment Manager, AEW.

Environmental, Social, Governance + Resilience ('ESG+R')

AEW, as Investment Manager of the Company, has committed to abide by the UN Principles for Responsible Investment (PRI), where these are consistent with operating guidelines, as outlined in its Socially Responsible Investment Policy. As a result, during the period, the Company and the Investment Manager has taken further steps to integrate ESG+R considerations into its investment, asset management and operations process. This has seen the continuous development of a number of initiatives, including asset sustainability action plans across all portfolio assets to inform and drive ESG+R agendas, the re-assessment of EPC's to prepare for upcoming regulation in relation to Minimum Energy Efficiency Standards and the integration of increased ESG+R considerations into the Company's investment process. As Investment Manager of the Company, AEW will continue to refine and improve its ESG+R policy in line with new legislation, such as the Task Force on Climate-related Financial Disclosures ('TCFD') and in line with industry best practices as they evolve.

During 2018, AEW established sustainability targets across its managed portfolio. The managed portfolio comprises service charged assets and vacant accommodation, which are those assets at which the Company has control over utilities. These targets include the reduction of Scope 1 and 2 greenhouse gas emissions and waste disposal. Since this time, overall energy usage has reduced by 15%, emissions have been reduced by 19%, and waste transferred to landfill has also been reduced to zero within the managed portfolio. We would like to thank the Company's very committed managing agents, Mapp, for their assistance in achieving these improvements.

GRESB is a global real estate benchmark that assesses Environmental, Social and Governance performance. AEWU achieved two stars in its seventh submission year, improving on its 2021 score to achieve an overall score of 67 out of 100 against a peer group average of 65. Much of the GRESB score relates to data coverage and due to the high percentage of assets in the AEWU portfolio with tenant-procured utilities, the Company does not score as well as peers with a smaller holding of single-let assets.

Succession Planning

Both Bim Sandhu and I have been Directors since the Company's IPO in June 2015. In seeking to comply with best corporate governance practice, we both intend to resign by 2024. In order to stagger our departures, we have determined that Bim, who chairs the Audit Committee, will resign at the AGM in September 2023 and I will resign at the AGM in 2024. The Board has also determined that our successors should have sufficient time to familiarise themselves with the Company before they formally take over our respective roles. With that in mind, in July 2022 the Board appointed Trust Associates, a firm specialising in recruiting NEDs for the investment trust sector, to produce a short list of eight candidates who would be suitable for the role of Audit Chairman. Four of the candidates were interviewed by the Board in October 2022 and were invited to a separate meeting with the Investment Manager. Following this extensive search, I am delighted to welcome to the Board Mark Kirkland, who was appointed as Non-Executive Director and Audit Committee Chairman designate with effect from 9 November 2022 and will take over From Bim at the AGM in September 2023. Mark brings extensive corporate experience gained over 30 years, having held numerous senior roles in public and private companies. Mark's initial career was in corporate finance, predominately with UBS Limited. He has been CFO of numerous public and private companies and latterly was CEO of Delin Property, a pan-European logistics developer, investor and manager. He is currently a NED and Audit Committee Chairman of Strix Group plc, and an Advisor to DP World. We will begin the process of finding my successor in mid-2023.

Outlook

The Board and Investment Manager believe that the Company is as defensively positioned as possible against the current challenging backdrop. Whilst further near-term value decline is expected, the Company's fixed cost of debt and book values which are closer to long term value fundamentals, such as alternative use values and replacement cost, provide a robust outlook for the portfolio over the long term. The portfolio's current high weighting to cash and value investment style leave it well placed to benefit from upcoming investment opportunities. The strategy's approach, being unconstrained by sector, and its active management style of the portfolio provide a strong basis for counter-cyclical performance. In addition, we are seeing resilience in occupational demand from the Company's tenants.

Investing the current capital available for deployment will be a key focus of the Company's Investment Manager over the coming months. The Investment Manager expects that value investment opportunities will be increasing in number over this period across all real estate sectors. Following full investment of capital available for deployment, the Company's earnings are expected to return to full cover of its 8p annual dividend, which has now been paid for 28 consecutive quarters.

In the near term, the Board and Investment Manager will continue to take a prudent approach towards the management of the Company, given the ongoing economic uncertainty. Economic conditions will be monitored closely and it is hoped that the UK's new Prime Minister, Rishi Sunak, will be able to restore an element of stability to the UK's financial markets.

Mark Burton

Chairman

15 November 2022

Investment Manager's Report

Economic Outlook

In common with most of Europe, the UK's macroeconomic outlook has been impacted by the conflict in Ukraine. With winter approaching, the sanctions-related energy crisis has pushed already high inflation to a record new high of above 10% in October 2022. This has put further pressure on the Bank of England to raise base rates. However, the outlook for inflation has become more uncertain following the fiscal U-turns announced by the new Chancellor in the third week of October 2022. On the one hand, a much tighter fiscal stance points to lower inflation in the medium-term. On the other, the curtailment of the cap on energy bills could push inflation up sharply in the spring of 2023. As of mid-October 2022, Oxford Economics projects the Bank of England base rate to peak at 4% in early 2023 and for it to remain at that level for more than a year. As these government policies and rate hikes will impact on mortgage interest rates, house prices and consumer spending, Oxford Economics forecasts, as of mid-October 2022, that GDP growth will be adjusted downward to 4.5% for the full year of 2022. More importantly, they project a fall of 0.5% in 2023 before returning to modest 1.8% growth in 2024. Investors and lenders will need to adjust to the slower economic growth and increased costs of debt as they might impact on both their acquisition or lending strategies and any loans coming up for refinancing.

Financial Results

The Company's NAV as at 30 September 2022 was £193.09 million or 121.88 pps (31 March 2022: £191.10 million or 120.63 pps). This represents an increase of 1.25 pps or 1.04% over the six-month period.

EPRA EPS for the period was 2.58 pence which, based on dividends paid of 4.00 pps, reflects a dividend cover of 64.50%. The decrease in dividend cover compared to the prior six-month period has largely arisen due to the Company completing a number of key sales, leaving it with a high cash weighting and a resulting loss of rental income in the short term. Earnings have been further depressed by one-off costs associated with refurbishment works being undertaken at Queen Square, Bristol and Mangham Road, Rotherham, which will both be accretive to the Company's earnings in the medium to long term. A high cash weighting leaves the Company advantageously positioned to select assets from the increased number of investment opportunities that are expected to present in the near term. The focus of the Company's investment strategy remains to return to full investment and full dividend cover. Income across the tenancy profile has remained intact. Collection rates have reached 99% for both the March and June 2022 quarters respectively, with further payments expected to be received under longer-term payment plans. Of the outstanding arrears, the Company has made a £0.59 million expected credit loss provision, given the deteriorating economic outlook. The Company will continue to pursue all outstanding arrears.

Financing

During the period, the decision was taken to complete the refinancing of the portfolio, as announced in May 2022. The Company has secured a new £60.00 million, five-year term loan facility with AgFe, a leading independent asset manager specialising in debt-based investments. The loan is priced as a fixed rate loan with a total interest cost of 2.959%. The existing RBSi loan facility, which was priced at a floating rate according to SONIA, was due to mature in October 2023 and has been repaid in full by the new loan facility. Simultaneous to the funding, the Company's interest rate cap was sold for proceeds of £743,000. In the current inflationary environment, the Company considered it prudent to fix the loan and interest, rather than run the risk of further interest rate rises nearer renewal. The Company intends to utilise borrowings to enhance returns over the next five years.

As at 30 September 2022, the Company has a £60.00 million loan Facility with AgFe, in place until May 2027, the details of which are presented below

Property Portfolio

During the period, the Company completed three disposals, being: Eastpoint Business Park, Oxford, for a price of £29.00 million; Bath Street, Glasgow, for a price of £9.30 million; and Moorside Road, Swinton, for a price of £1.71 million. The Company made two acquisitions during the period, being: Dewsbury Railway Station Retail Park, which was acquired in June 2022 for £4.70 million, and JD Gyms, Glasgow, which was purchased in August 2022 for a price of £2.60 million.

The following tables illustrate the composition of the portfolio in relation to its properties, tenants and income streams:

Summary by Sector as at 30 September 2022

Summary by Geographical Area as at 30 September 2022

*like-for-like rental growth is for the six months ended 30 September 2022.

Source: Knight Frank/AEW, 30 September 2022.

Individual Property Classifications

The Company's top ten properties listed above comprise 50.0% of the total value of the portfolio.

Sector and Geographical Allocation by Market Value as at 30 September 2022

Sector Allocation

Geographical Allocation

Source: Knight Frank valuation report as at 30 September 2022.

Top Ten Tenants

The Company's top ten tenants, listed above, represent 32.6% of the total passing rental income of the portfolio.

Source: Knight Frank valuation report as at 30 September 2022.

Asset Management

The Company completed the following material asset management transactions during the period:

Acquisitions - The Railway Centre, Dewsbury, was acquired in June 2022 for £4.70 million and is a 6.04-acre railway station retail park, occupying a prominent location on the edge of the town centre within an established retail and leisure area. The asset provides an attractive net initial yield of 9.4%. The second acquisition, JD Gyms, Glasgow, is a high yielding leisure asset, providing a NIY of 7.4% and a low capital value of £99 per sq. ft. Both of these assets provide strong and stable income streams from their tenancy profiles.

Disposals - Sales of Moorside Road, Swinton for £1.71 million; Eastpoint Business Park, Oxford, for £29.00 million; and Bath Street, Glasgow, for £9.30 million. The Swinton and Oxford sales prices produced IRRs in excess of 13% and 22%, respectively. The sale of Glasgow realised a long-term change of use strategy where full vacant possession of the building was achieved. Following its sale, the occupancy rate for the remaining portfolio increased by circa 4%, all else being equal. Reinvestment of the sales proceeds is expected to provide a significant boost to the Company's earnings, due to both higher levels of anticipated income and lower running costs.

Arrow Point, Shrewsbury - During May 2022, the Company completed the renewal of Charlie's Stores' lease on a straight 10-year term at a rent of £385,000 per annum reflecting £11 psf, versus an ERV of £7.50 psf. Charlie's Stores is the scheme's anchor tenant, so this is an important letting for the property. Only nine months' rent-free incentive was given.

40 Queen Square, Bristol - The Company completed an agreement for lease with existing tenant

Konica Minolta Marketing Services Ltd on the third floor. The tenant will enter into a new ten-year lease with a five-year tenant break option at a rent of £218,840 per annum, reflecting a new high rental tone for the building of £40 per sq. ft. The letting is subject to landlord refurbishment works including roof, lift and reception upgrades at a cost of £1.07 million plus 11 months' rent-free incentive. Landlord works commenced during the period and are due to complete before the end of the year.

Commercial Road, Portsmouth - During May 2022 the Company completed a new 15-year lease to Kokoro UK Limited, a Japanese-Korean restaurant. The agreed rent is £52,500 per annum versus an ERV of £45,750 per annum. The tenant has the benefit of a 12-month rent free period and a tenant only break option at the end of the tenth year.

Diamond Business Park, Wakefield - During June 2022, the Company completed a new letting of Units 8 and 9 to Wow Interiors, an existing tenant on the estate already occupying Unit 7. Wow have taken a new six-year lease with a tenant break option at the end of the third year. The commencing rent of £3 psf will increase to £3.50 psf in years 2 and 3, and subsequently £3.75 psf from year 4 onwards. In doing so, the Company has also completed a lease re-gear on Unit 7, removing Wow's 2022 tenant break option and agreeing a three-year reversionary lease with a tenant break option mirroring Units 8 and 9.

Mangham Road, Rotherham - The Company has completed a new ten-year ex-Act lease to Senior Architectural Systems Ltd at a rent of £410,000 per annum, reflecting a rent of £5 per sq. ft. This shows a significant uplift to the rent paid by previous tenant, Hydro Components, at £275,000 per annum. The lease provides for five-yearly rent reviews to the higher of open market rent or RPI, with collar and cap at 2% & 4% per annum, respectively. There was no rent-free incentive granted to the tenant, however the landlord undertook works to upgrade the building at a cost of £964,700. These works were completed during the period and are expected to improve the asset's energy efficiency. The tenant benefits from a break option at the end of year five.

Bank Hay Street, Blackpool - Repair works at the property which commenced in 2020 have now reached practical completion. The total cost of these works amounted to circa £2.40 million, of which approximately £800,000 is expected to be recovered from tenants. The recoverable elements of this expenditure have been raised within the service charge budget and all tenants are up to date with payments.

Vacancy - The portfolio's overall vacancy level is 8.48%.

Environmental, Social and Governance ('ESG') Update

The Company has maintained its two stars Global Real Estate Sustainability Benchmark ('GRESB') rating for 2022 and improved its score to 67 (GRESB Peer Group Average 65). A large portion of the GRESB score relates to performance data coverage where, due to the high percentage of single-let assets with tenant procured utilities, the Company does not score as well as Funds with a smaller holding of single-let assets and a higher proportion of multi-let assets where the owner is responsible for the utilities and can therefore gather the relevant data.

We continue to implement our plan to improve overall data coverage and data collection for all utilities through increased tenant engagement at our single-let assets and by installing automated meter readers ('AMR') across the portfolio. So far, we are in the process of installing AMRs in all of our multi-let properties. We are also in discussions with the tenants of our top 10 single-let FRI assets (in terms of floor area) regarding the installation of AMR.

We endeavour, where the opportunity presents itself through a lease event, to include green clauses in leases, covenanting landlord and tenant to collaborate over the environmental performance of the property. Green clauses seek to improve data coverage by ensuring tenants provide regular and appropriate utility consumption data.

We continue to assess and strengthen our reporting and alignment against the Framework set out by the TCFD, with further disclosure to be provided in the 2023 annual report and accounts. We are pleased to report that the Company has maintained its EPRA Silver rating for sBPR for ESG disclosure and transparency.

We have an Asset Sustainability Action Plan ('ASAP') initiative, tracking ESG initiatives across the portfolio on an asset-by-asset basis for targeted/relevant and specific implementation of ESG improvements. In doing so, all managed assets and units have recently been contracted to High Quality Green Tariffs, ensuring that electricity supply is from renewable sources. All void/vacant unit supplies have also been transferred to High Quality Green Tariffs.

All managed assets will be moved to 'Green Gas' supplies in 2022.

We are underway with implementing a number of initiatives across our portfolio, including a new landscaping/biodiversity programme at our retail warehouse in Barnstaple, replacing the existing plants and shrubs with a greater diversity of appropriate species which in turn will attract a wider variety of insects and wildlife to the property.

Lease Expiry Profile

Approximately £2.91 million of the Company's current contracted income stream is subject to an expiry or break within the 12-month period commencing 1 October 2022. 26.68% (£776,757) of this income is in the industrial sector, where we anticipate strong occupier demand, low incentives and reversionary rents. Regarding the remainder, we will proactively manage, looking to unlock capital upside, whether that be through lease regears/renewals, or through refurbishment/capex projects and new lettings.

Source: Knight Frank valuation report as at 30 September 2022.

AEW UK Investment Management LLP

15 November 2022

AEW UK REIT PLC's interim report and financial statements for the period ended 30 September 2022 will be available today on www.aewukreit.com.

It will also be submitted shortly in full unedited text to the Financial Conduct Authority's National Storage Mechanism and will be available for inspection at   data.fca.org.uk/#/nsm/nationalstoragemechanism  in accordance with DTR 6.3.5(1A) of the Financial Conduct Authority's Disclosure Guidance and Transparency Rules.

LEI: 21380073LDXHV2LP5K50