Ground Rents Income Fund (GRIO) has provided a strategy update, portfolio valuation and shareholder consultation ahead of its upcoming continuation vote. This follows on from a shareholders’ decision in April 2023 to opt for a managed wind-down of the company. Shareholders also approved a change to the company’s Articles to replace the obligation to hold a vote on a wind-up resolution with an obligation to hold a continuation vote before 31 December 2024. The new continuation vote mechanism requires a simple majority of votes cast to pass, with subsequent continuation votes to be held at three yearly intervals beyond 2024.

Strategy update

As set out in the GRIO’s recent interim accounts, the key strategic steps required to deliver the investment policy are as follows:

• Sell assets where possible to optimise the net realisation value of the Company’s investments, whilst repaying debt and improving the liquidity of the remaining portfolio;
• Continue to engage positively with the UK Government of the day (‘the Government’) to advocate for leasehold reform that fairly balances the interests of our shareholders and our leaseholders;
• Work with the Company’s independent valuer, Savills, to ensure it has all relevant available information concerning building safety remediation projects and leasehold reform related issues to reduce valuation uncertainty; and
• Maintain a robust balance sheet, whilst also minimising expenses to maximise free cash.

Progress on assets sales and debt repayments

On 22 February 2024, GRIO sold two freehold ground rent interests in Bristol and Exeter for £3.45m, which represented a 4% premium to the independent valuation of £3.3m as at 30 September 2023. The assets were let to a single institutional leaseholder and operated by Vita Student Management Limited as purpose-built student accommodation. These freehold assets were acquired by the company’s long leaseholder.

GRIO says that further disposals are in progress and others in pre-marketing preparation, with significant work ongoing to improve the liquidity of the underlying portfolio, such as enhanced legal due diligence and managing legacy issues. It adds that uncertainty relating to building safety and leasehold reform means transactional volumes are very low across the ground rent market. Future disposal proceeds are likely to be used to repay debt in the first instance, to help to reduce the effect on interest payable following the expiry of current hedging instruments in January 2025.

Progress on engaging with the government on leasehold reform

In May 2024, the previous government introduced the Leasehold and Freehold Reform Act as part of the ‘wash up’ process immediately before the dissolution of Parliament and the general election.

GRIO says that the act represents a better outcome for it than contemplated in the government’s November 2023 consultation that sought views on restricting existing residential ground rents payable, but without compensation paid to freeholders adversely affected. However, the Act also contains provisions relating to the enfranchisement process that GRIO says are potentially unlawful and could negatively impact the portfolio value further. It adds that many of the Act’s key provisions will only come into force once the Secretary of State passes additional secondary legislation.

The government has confirmed it will seek to implement provisions within the Act and further reform the leasehold system, including to tackle ‘unregulated and unaffordable’ ground rent, via a new Leasehold and Commonhold Reform Bill.

GRIO says that it continues to advocate for leasehold reform that fairly balances the interests of shareholders and leaseholders, which includes informal engagement with the government alongside formal legal action.

Progress on work with Savills

GRIO says that its advisers have worked closely with the independent valuer, Savills, to ensure it has all available information relating to building safety remediation projects and leasehold reform. Savills has also liaised with peers and the Royal Institution of Chartered Surveyors (‘RICS’) as part of preparing its valuation.

Following this process, Savills has confirmed an unaudited independent portfolio valuation as at 30 September 2024 of £71.5m, representing a like-for-like reduction (net of disposals) of £31.3m or 30.5% over the financial year to 30 September 2024 (valuation as at 30 September 2023: £106.1m or £102.8m on a like-for-like basis). Over the six-month period to 30 September 2024, this represents a fall of £10.1m or 12.4% (valuation as at 31 March 2024: £81.5m).

This reduction is principally due to the previous government’s approach to leasehold reform in November 2023, including as set out in the consultation. Savills, in discussion with peers and the RICS, continues to adopt a Material Valuation Uncertainty Clause (‘MUC’) that (according to Savills and other valuers) applies across the entire residential ground rent market because of uncertainty relating to leasehold reform and the resultant lack of transactional evidence. This MUC affects 97% of GRIO’s portfolio by value as at 30 September 2024 (31 March 2024: 97%).

A separate MUC also applies to assets impacted by building safety related defects, noting that the building remediation projects carried out across the portfolio over the financial year have reduced the negative impact on the unaudited valuation.

Further detail relating to the independent portfolio valuation and the resultant impact on the company’s net asset value (‘NAV’) will be included in the forthcoming full year results to 30 September 2024.

Progress on balance sheet strength

In March 2024, GRIO completed a refinancing with Santander, with disposal proceeds used to reduce the loan to £19.5m from £21.0m. The loan term was also extended from January 2025 to July 2026, allowing GRIO more time to execute its investment policy. Based on the unaudited Savills valuation as at 30 September 2024 of assets charged to Santander totalling £39.0m, the Loan to Value (LTV) is 49.9% compared with a LTV covenant ratio of 50%. The independent valuation obtained by the bank for the charged assets in March 2024 was £53.6m, which reflected a LTV of 36.4%. GRIO says that it is compliant with loan covenants and, alongside planned disposals, has cash of £5.5m with the ability to repay debt, if required.

The new loan has a margin of 2.75% which, together with the interest rate hedging in place until January 2025, results in a total interest rate of 3.96% and an interest coverage ratio (ICR) of 318%, compared with a current ICR covenant ratio of 200%. Following expiry of the interest rate hedging, before any further disposals and debt repayment, and assuming the current SONIA rate of 5.1%, GRIO says that its total interest rate would increase to 7.85% in January 2025. As part of the recent refinancing, the ICR covenant level will, at the same time, reduce from 200% to 160%. On the same basis and before any new hedging arrangements, the ICR in January 2025 is forecast to fall to 160%. Based on the total unaudited independent portfolio valuation as at 30 September 2024 for charged and uncharged assets, the Group LTV, net of cash, is 19.6% (31 March 2024: 17.9%).

Alongside the expected increase in the loan interest rate, GRIO says that it continues to incur elevated non-recoverable legal and other professional fees and expenses relating to leasehold reform and building safety, also including additional fees paid to the manager and non-executive directors relating to out-of-scope work as demonstrated in the recent interim accounts.

Considering these elevated expenses, GRIO’s size and the remaining strategic steps necessary to execute the investment policy, the board considers it is both timely and appropriate to reduce the number of directors (all non-executive) from four to three. As such, Jane Vessey will retire from the board with effect from 31 December 2024.

GRIO says that the increased expenses are continuing to dilute earnings, noting that it is currently prevented from paying dividends due to the modified auditors reports relating to the full year results to 30 September 2022 and 2023. GRIO adds that it is not yet clear whether this modification will continue to apply to the forthcoming September 2024 year end results, but it is likely to take a cautious approach to future dividend payments given prevailing uncertainty and the loan maturity in July 2026.

Timing and next steps

GRIO says that Singer Capital Markets will be contacting larger shareholders requesting initial consultation meetings to be held in October. Following these meetings, GRIO aims to publish a shareholder circular around the end of October, with an Extraordinary General Meeting taking place in November 2024 for the continuation vote. Preparation for, and the audit of the company’s full year accounts for the year to 30 September 2024 are running in parallel with the continuation vote process, with the aim of releasing the year end results during December.