There are two themes in play for Lifestyle Communities. Higher interest rates are theoretically affecting the value of LIC’s rental streams, but demand for land lease community lifestyle living is undiminished.
LIC’s share price has fallen around 25% in the last four months as the market appears to be factoring in a ~125bp expansion in the cap rate applied to value the group’s rental streams.
The rental capitalisation rate adopted in LIC’s balance sheet as at December 2021 was 5.5%-5.75% and was unchanged from 30 June 2021.
The shift in interest rate expectations partially justifies this, but we argue there are numerous structural tailwinds that should mitigate this perceived cap rate expansion. These include capital inflows to the sector, government backing of rental payments through the Aged Pension, substantial equity release and limited debt funding of settlements.
The fundamental economic factors driving the sector will inevitably shine through. A generation of (near) retirees are looking for a high-quality, affordable housing solution such as those that land lease communities can provide. LIC’s current portfolio consists of 13 existing, fully occupied communities with 2,504 homes, 6 communities under construction and a further 6 awaiting commencement. In total, that is 5,231 homes with 3,210 sold and occupied or waiting for settlement. The average home price across the portfolio is just over $500,000.
LIC’s 1H22 result was typically characterised by strong growth in settlements (116 new homes, 68 resales), a solid lift in rental revenue and further expansion of the development pipeline. LIC is expecting to deliver between 1,100 and 1,300 settlements over the 3 years to FY24f.
LIC’s 1H22 result was a mixed bag with revenue of $93.9 million up 83% over last year (affected by COVID). Rental revenue was good with the completion of several clubhouses initiating the start of rental payments at those communities. Higher corporate costs, digital transformation costs and some legal fees took a bite of operating EBIT of $13.8 million (excluding fair value adjustments of $26.2 million).
Investment view
The underlying factors supporting the land lease community property space are strong positive catalysts that will offset the impact of rising policy rates. Even allowing for a higher cap rate, we believe the share price is being unfairly penalised and now presents an opportunity to accumulate stock.
Risks to investment view
The disaggregation of the Australian advice channel may have as great an impact on IRE revenues as expected. The Superannuation and Investment Infrastructure segments might not gain the traction anticipated and the group might not gain the penetration of the UK Wealth management landscape targeted. Foreign exchange rates could also hurt the translation of profits.
Recommendation
We have retained our Hold recommendation.
