Schroder European Real Estate 08 August 2023

Schroder European Real Estate (LON:SERE) is a unique diversified UK listed REIT, with a focus on commercial property in the strongest cities in Continental Europe. A key difference between European and UK commercial property is that there is often explicit inflation CPI links in lease terms in Europe, which is referred to as ‘indexation’. Approximately 80% of the portfolio income is subject to indexation leases, with the balance still having some form of annual rental increase hurdle.

SERE is managed by Jeff O’Dwyer, who oversees the practical implementation of Schroder Capital’s ‘winning cities’ strategy, which focuses on European cities with faster-than-average GDP, population, and employment growth. As a result, there is a bias towards Germany, France, and the Netherlands in the portfolio. Local implementation of the strategy relies on Schroder’s extensive network of multi-sector property experts across Europe and their operational real estate approach to ensuring a strong and sustainable relationship between owner and occupier which is increasingly key to asset performance. The team is constantly assessing ways to invest in the portfolio to enhance its sustainability credentials, which is an increasingly important factor in driving long-term rental growth.

SERE’s current dividend has been recently rebased to a fully covered basis and provides a dividend yield of c.6.3% and a more solid basis to grow the dividend in future years.

SERE has modest gearing of 23% LTV net of cash, and has a range of debt maturities from 2023 to 2027, with a significant refinancing of its main 2023 debt already completed. SERE trades on a discount of c.34% compared to its five-year average of c.20%.

Rising interest rates are naturally a primary concern for investors. SERE, like almost every other REIT, has seen its valuations reduced in response to higher rates. A well-timed recent disposal has positioned SERE favourably, reducing office allocation and increased its cash position with a view to reinvesting into the portfolio to improve sustainability and asset quality together with the potential for new investments.

As we discuss in the Gearing section, SERE has a number of refinancings due over 2023/24. The first of these was successfully executed recently, with Jeff reporting that there were competitive bids from several banks given the strength of the underlying assets. The cost of debt has increased, however Jeff says that margins remain competitive for good quality real estate managed by strong specialists like Schroders. The overall rate remains attractive and below the yield on the portfolio, providing the all-important positive spread between the two.

Jeff reports that there have been no issues with tenants refusing to accept indexed rent rises as higher inflation has fed through to higher rents. This explicit link to inflation helps explain why SERE’s portfolio valuation has fallen less than the average for UK REITs. In a low inflation environment perhaps investors might have seen indexation as a somewhat hypothetical diversifier, but the last year has cast a new light on this important feature of European commercial property.