The Abrdn Property Income (API ) / Custodian Property Income (CREI ) Reit merger is not happening, having gained insufficient support from API shareholders. There is a strong presumption that API will now enter managed wind-down (most articles seem to think that this is a done deal), but this is an idea that the board came up with and would need approval from shareholders.

I now have more of a direct interest in this as I have bought a few shares at 51.5p. The share price moves of CREI and API since the deal was called off strongly suggest that merger arbitrageurs were at work here, trying to eke out a gain by selling CREI shares and using the proceeds to buy API shares, which works if the two share prices do not fully reflect the terms of the proposed merger.

Anyway, with the deal off, the arbs were forced to buy back CREI shares – driving up that share price – and sell API shares, depressing the price to a level where I thought they were too much of a bargain to ignore. I figured that this would be a short-term opportunity, but if I had waited, I could have bought them for even less than I did.

So, what do I own a stake in? The last published net asset value (NAV) for API was just under £300m or 78.4p per share. There will be some expenses related to the abandoned merger to come off that, though hopefully, these will not be too extortionate. The £140m of debt at the year-end equates to a loan-to-value ratio of 30.8%, and the total value of the portfolio was £439m at the end of 2023.

It has a big bias to industrial properties which make up 57% of the portfolio. This was the hot sector in the UK property market for some time but was caught by the general selloff that accompanied rising interest rates. Nevertheless, even after that, the portfolio has produced returns that are well ahead of the MSCI benchmark over the past three years with a 12.6% gain against the benchmark’s 4.7%.

Part of my argument for rejecting the deal was that API has been demonstrating that it can sell property at fairly close to NAV. The most recent of these were the sale of an office in London at a 7.1% discount to the NAV at end September 2023, and the sale of an industrial estate in Warrington at a 5.5% premium to the end September valuation.

The figure achieved for the office may look troubling but, after this sale, API has just £7m in central London offices, £22.8m in offices elsewhere in the South East, and £32m of offices in the rest of the country. This contrasts with £244m in industrial property.

The flurry of consolidation in the property sector comes in the wake of a difficult few years for the sector. Covid-related disruption has had a lasting impact on demand for office space and put serious financial strain on many tenants, which has been compounded by a weak economy – the number of insolvencies is running close to record highs.

More recently, higher interest rates have led to higher property yields, driving down valuations, and causing problems for indebted investors. There are concerns about the volume of upcoming debt refinancing and whether this will lead to some forced sales.

However, rates have peaked and hopefully will be coming down in the second half of the year. The mood for 2024 is more upbeat. Savills expects to see higher volumes of property transactions and lower yields for prime property, for example. One positive is that the weak markets of the past few years have deterred development activity, which helps with the balance of supply and demand. Nevertheless, API’s managers are cautious – they think that out-of-favour sectors could still see falling values in the first half of 2024.

My best guess is that the wind-down will proceed. At 51.5p the shares stand on a 34.4% discount to NAV, suggesting that there is 52% upside if I could get out at asset value, which leaves plenty of wiggle room. I think there is a good chance that the NAV could start to rise again this year but probably more towards the back end of the year.

If shareholders reject the wind-down, it becomes a question of when will the sector and this trust re-rate. In the meantime, the key attraction is the yield. The board promised to maintain the dividend at 4p per share for 2024, which equates to a 7.8% yield on 51.5p. However, a big jump in the fund’s interest bill last year means that this is not covered. Even if the plan is to keep going, the manager will continue to sell property to reduce the level of the debt and improve dividend cover. There must still be a chance of a dividend cut, which I acknowledge would not do wonders for the share price (which has slipped to 49p since I wrote this).

So, this could take a year or two or three to come right, but overall I am optimistic.

James Carthew is head of research at QuotedData.

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