Starwood European Real Estate Finance (SWEF) lends against commercial property in Europe and the UK. As a provider of debt financing, SWEF sits further up the capital structure than equity investors, such as most trusts in the AIC UK Commercial Property sector. This means its track record of steady returns has not been disrupted by the pandemic, as we discuss in the performance section.
SWEF has been able to maintain its dividend payments over 2020 and also not seen falls to its portfolio valuation. Despite displaying resilience throughout the pandemic, the shares have not fully recovered from the March 2020 crash, and trade on a 12.4% discount to NAV.
SWEF mostly lends at floating rates. Although it has paid a 6.5p dividend each year since 2015, from 2021 the payment will be rebased to 5.5p as a consequence of the relentless march downwards in the interest rates off which its loans are priced. On a forward-looking basis we estimate that the share price yield is currently 6.1%.
SWEF has exposure to sectors which have been operationally affected by COVID such as hospitality (36% of NAV) and retail (13%). However, it has seen no missed interest payments through the crisis, nor taken impairments for expected losses. The loan to value on the portfolio is just 61.8%, giving a substantial equity cushion, and SWEF has modest gearing at the portfolio level of just 3.7% of NAV.
SWEF is managed by a subsidiary of Starwood Capital Group, one of the largest real-estate investors in the world, which brings a huge origination platform, specialist knowledge and strong relationships in the industry.
SWEF seems like one of the relatively few trusts to have been left behind by the reflationary wave of Q4 2020. Most discounts have narrowed while markets have rallied, but SWEF’s discount remains relatively wide. In our view this could be an opportunity. The vaccines offer a path to normalisation of economic activity which should support the cashflow of SWEF’s borrowers. While we accept the path could yet be rocky, it seems anomalous to us that investors are demanding a 12.4% discount for SWEF compared to just 2% for its closest peer (see discount section).
Meanwhile the dividend yield of 6.1% compares to the 4.5% offered on average by the generalist UK commercial property equity trusts, which in our view have much more realistic chances of seeing their capital values written down in 2021. It is also worth noting the 2.5% yield on the ICE BofA Euro High Yield Index – a 6.1% yield is rare in today’s environment.
We think the discount must be compensating for perceived default risk. However, as we discuss in the performance section, the managers have not taken any impairments to their loan book, and believe they will not see any credit losses as a result of the pandemic. Borrowers are incentivised to maintain their interest payments as any renegotiation would class as a default, giving lenders power over the assets. This is very different from the equity sector which has seen a lot of rent renegotiations (down, chiefly). In our view SWEF offers a higher yield than the equity REITs with lower risk to capital values. Investors do have to take significant exposure to the retail and hospitality sectors though, which adds some uncertainty.
|High yield relative to equity markets and equity commercial property trusts
||High reinvestment risk over the medium term, requiring stream of new investments to maintain income
|Modest LTV on the underlying loans reduces risk of impairments
||Hospitality and retail will face operational pressures even while restrictions and lockdowns loosen
|Loans are high up the capital structure, reducing likelihood of borrowers missing payments
||Concentrated portfolio increases risk if one of the largest loans is impaired