Watkin Jones, which was admitted to AIM in 2016, is a UK-based developer specialising in purpose-built accommodation for the student and private rented sector markets. In both cases, the company buys land, builds accommodation blocks and then sells the whole development to pension fund investors who like the long-term visibility of the rental income. What differentiates the business is that not only is it the developer and contractor but it’s also the end-operator, taking on project management responsibilities for 5-7 years after completion.
Over the last two years, market activity has been slower than anticipated, affecting transaction closures. This slowdown has largely been attributed to interest rates/gilt yields rising materially, which has resulted in less demand from institutional investors. However, as chief executive Alex Pease notes, during the global financial crisis - the last major property downturn - the sector subsequently emerged as one of the strongest performers in commercial property.
After a prolonged period of sluggishness, conditions are turning positive as investors begin to ponder the downward trajectory of interest rates in coming months. With the company’s share price having fallen by £2 over the past four years to 24.5p, there has been director buying in recent months, signalling confidence.
Established in 1791
Watkin Jones was established in 1791 and until seven years ago was still being run by the family - the ninth generation in fact! It had started life as a modest joinery workshop before moving into the construction of commercial buildings (eg. Premier Inns) and housebuilding, and then onto student accommodation blocks. It developed its first purpose built student accommodation in 1999 and PBSA subsequently became its bread-and-butter.
During the month I met with Pease, who took the reins in 2023 (having been investment director since 2013). As he explains, most universities (with the notable exceptions of Oxford and Cambridge, which have vast amounts of property and art) are brassic. In 2024, 41% of 18-year olds in the UK applied to go to university (the second highest number) but the problem has been that since 2017, undergraduate tuition fees in England have been capped at £9,000 with only a small increase put through this year; these fees have been eroded in value by high inflation, forcing universities to rely on uncapped tuition fees from international students to balance their books. But a notable drop in international applications caused by increased UK visa fees, restrictions introduced by the UK government and weakening currencies in countries including India and China, have created funding problems for many universities.
Whilst most universities provide first year accommodation on campus, many have been circumscribed for years to invest in accommodation and are therefore open to privately provided PBSA for subsequent years of the type built by Watkin Jones, where the facilities have ensuites, internet connectivity, good communal space and security.
In the early years of building student accommodation blocks, Watkin Jones would speculatively build a block using development finance and find a buyer post completion but the banking crisis in 2008-9 brought a near death experience when seemingly overnight it couldn’t find any buyers for its sites and HBOS demanded repayment of its £150m loan.
A fabulous silver lining to that dark cloud emerged when Watkin Jones adopted a new business model - “a forward sales model” - where Pease turns to investors to forward fund its student developments.
Once a suitable site is found, the company purchases the land outright or secures an option (e.g. for a 500-bed scheme, it might pay £5m for the land or spend £500,000 on a refundable option). However, acquiring land alone is not enough - obtaining planning permission, which is done in-house, is a crucial step that determines whether the development can move forward.
Working-capital-light model
Upon receipt of planning permission, Watkin Jones forward-sells the bare land to a blue-chip institutional investor, so if it has spent £5m on the site and a further £0.3m on the planning application process, it might then sell the site for, say, £7m for a £1.7m gain - this “land margin” is the first part of its profit. The institutional investor then funds construction through monthly payments as development progresses.
Unlike a traditional housebuilder, which recognises profits when it finishes building a house and hands over the keys, Watkin Jones will have agreed contractual terms, and bills the customer monthly on an as-completed basis to maintain cash flow.
Developments usually take 18-24 months to be completed, however revenue starts to be recognised at the start of development. It doesn’t actually do the blue collar stuff like laying bricks but uses a well developed supply chain, which keeps margins high. A bullet payment, typically 10%, is retained by the customer until the project reaches completion, ensuring accountability.
In my notional example of 500 beds, say the build cost was £22m. Watkin Jones might expect to make a £5m construction profit and so this “build margin” is the second part of its income.
It is worth highlighting that the profitability and margins on projects largely depend on land costs and different rental dynamics in a given location. For instance, whereas a 400-bed scheme in Liverpool might have a £180 rent per week and deliver a c£32m development value, working out at c£80,000 per room, the same scheme in London, where gross rents are £300 per week but yields lower, could give a capitalised value of c£60m, working out at c£150,000 per room.
Asset management teams
The buyers for its accommodation blocks are typically institutional investors and large pension and insurance funds. They have the capital to develop large blocks and they like the stable, long-term income stream. But Watkin Jones’ involvement often continues after the final brick is laid. A development requires expert management and Watkin Jones also has an asset management arm (Fresh) that will oversee maintenance and the tenancy, ensuring the development remains profitable and well-maintained. Fresh might receive c£300 per bed for ongoing management annually, so a 500 bed scheme, for instance, will generate £150,000 annually for it, which repeats each year. The work is self delivered with 350 of the group’s 700-strong headcount accounted for by Fresh.
Fresh is the third largest managing agent for PBSA assets in the UK and contracts typically run for 3-7 years. Contracted beds under management fell last year to c6,800 beds due to a portfolio moving back in house but it still has 18,656 beds under management across 58 sites currently, generating £8.1m sales last year.
Last year Watkin Jones also introduced a brand new service (Refresh) to refurbish residential assets in accommodation blocks and it has identified over 500,000 PBSA beds that were built a decade ago, as well as a lot of university-owned blocks. Work can vary from fire improvement works to the refurbishment of bedrooms, bathrooms and kitchens.
As Pease says, this type of work is not subject to planning and is intended to complement newbuild. He anticipates good growth in FY25 with a £100m tracked revenue pipeline. But it isn’t all plain sailing: some of the work is also mandatory and Watkin Jones has given an undertaking to fix fire cladding on five of its past builds, which will cost £48m (costs for this were fully provided for in the 2023 accounts); this isn’t Pease being altruistic - like all contractors Watkin Jones is required to do so under the Building Safety Act, which kicked in during 2022 and has extended the limitation period to 30 years for those putting up new buildings.
Finding another way to grow
In FY24, PBSA developments contributed revenue (including Fresh and Refresh) of £128.5m. This was down a third year-on-year but doesn’t tell the full story: turnover included new contracts in the year (a 260 bed scheme forward sold in Bristol) and also ongoing profit recognition on contracts exchanged in previous years as the build programme spans a number of years (Nottingham, Bristol and Bath). However, it excluded a 397-bed development in Stratford, East London, which was sold to a new joint venture (25% WJG share) created with the Housing Growth Partnership (HGP), a social investor. This transaction was accounted for as the disposal of a subsidiary rather than a land sale, so it wasn’t included in the turnover figure; if it had been, it would have added c£25m to divisional turnover.
Pease says the JV was partly a reaction to the slower markets, adding that the JV is expected to sell the completed scheme once it is stabilised, which could give it greater upside as the market improves. Overall, however, this resulted in a FY24 divisional gross margin of 11.6% (FY23: 6.5%) and adjusting for the fact that build margins of certain in-year schemes are lower than typical land margins, this “reflects a recovery towards the margins we have historically earned in this sector,” he adds.
….BTR makes the running
Since 2017, Watkin Jones has been applying the same set of skills (site sourcing, planning, transaction funding, construction and delivery, and asset management) to the build to rent (BTR) sector, with similar investors to those in student accommodation.
In FY24, revenues from BTR rose by 1.7% to £211m, generated by the build-out of three forward sold developments (Hove, Lewisham and Birmingham) although again a lack of land sales resulted in a lower gross margin of 8.5% (FY23: 9.5%).
Watkin Jones’ increasing focus on BTR is underpinned by several factors: significant investor demand for its expertise, growing rental demand and an increasing preference from renters for a new and better class of accommodation. I was surprised to learn that the sector is still small with only 123k completed flats and houses UK-wide but there are 285k at some stage of planning and there is strong tenant demand from those who seek to rent these newer living spaces with better amenities, greater security, longer tenancy options and responsive professional management that is synonymous with BTR - many features that are often hard to find in the private sector. The number of traditional private landlords is shrinking; most I know presently have a haunted look of despair on their faces due to rising taxes and duty burdens and are quitting the buy to let market. At the same time, supply remains constrained by planning bottlenecks, so rents have been rising across the board.
At any one time, Watkin Jones may have a dozen developments ongoing but the forward sales structure reduces capital tie-up in any one and significantly de-risks development, with Pease targeting a c20% gross margin hurdle for PBSA and 15% for BTR for new developments (the difference is accounted for by greater build density with more units per acre for PBSA, says Pease).
A strong indicator that the BTR market remains alive and well is the recent entry of new players, such as Goldman Sachs (after a period of absence) and an Australian investment vehicle, even before the trajectory of interest rates becomes clearer.
Total pipeline of £2bn
Latest full year results saw revenue dropping c12% to c£362m, with gross profit down 3% at £33.8m, while pretax profit moved from a loss of c£3m last year to a profit of £9.8m, with EPS of c3.7p.
Watkin Jones entered FY25 with a substantial pipeline of £2bn across 24 schemes in various stages of undress. Contracted revenue from sites sold is £292m covering 2,600 beds, with a three-year delivery profile (£232m in BTR and c.£60m in Student). Pease has four developments with planning on the market which, should they complete, will give some land profits this year. Broker Peel Hunt forecasts a lower pretax profit of £3.5m and EPS of 1.2p for this year to end September, climbing to £14m and 4.9p, respectively, next year.
And the shares are clearly starting to look ahead. Changes to planning laws, set to take effect in early April, should aid the supply of development pipeline projects, and further rate cuts will likely lead to competitive bidding on its developments on the market. Greater competition will in turn result in yield compression and stronger margins. Meanwhile, Watkin Jones has availed of the slowdown to acquire land at reduced prices. With net cash of approximately £83m, it has already gone under offer on four sites since the year end. I am a buyer.
