Schroder European Real Estate 20 March 2024

Schroder European Real Estate (SERE) is a diversified REIT focussing on European commercial property with an emphasis on 'winning cities’ in Europe. Manager Jeff O'Dwyer says it's not enough to focus generically on winning cities though, and a clear understanding of location is required, be it proximity to the right junction of a major road, a commuter transport hub, supply-constrained, or a location with strong alternative use potential. With over 200 professionals in local offices across Europe, the management team is very well-placed to assess each asset in ways that might not be obvious from a desk in London.

SERE is managed by Jeff O’Dwyer, who oversees the practical implementation of Schroder Capital’s ‘winning cities’ strategy, which focusses 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.

A key difference between European and UK commercial property is that there are often explicit inflation links via CPI in lease terms in Europe, which is referred to as ‘indexation’. SERE's portfolio is 100% exposed to some form of local indexation, and Jeff reports that even at higher inflation rates, indexed rents have all been accepted by tenants. SERE's dividend yield of 6.3% is fully covered, following a rebasing of the dividend in 2023.

SERE has modest gearing of 24% LTV net of cash and completed a number of refinancings against specific assets on good terms in 2023, maintaining the positive carry between property yield and interest cost. The trust has c. €26m of cash available either for earnings accretive acquisitions or upgrades to the existing portfolio. At the time of writing SERE trades on a discount of c. 36% compared to its five-year average of c. 20%.

One of the issues on investors’ minds in the last year or two has been debt refinancing, particularly when it comes to REITs. SERE executed a number of refinancings over that period, and as we discuss in the Gearing section, the terms have been favourable and despite higher absolute costs, spreads have reduced and the positive carry between debt costs and property yield remains in place. With the dividend now rebased to a fully covered position, and leases in the portfolio 100% indexed against local inflation, SERE is well-positioned. In addition, it has retained c. €26m of cash and commenced sustainability audits across the majority of the portfolio to assess ways to invest in and improve asset quality. This will assist in growing earnings and enhance liquidity to occupiers, lenders, and investors.

With €26m of cash, SERE has the capacity for further acquisitions or capex on the current portfolio. The manager believes there is a significant ‘green premium’ to be earned through upgrading buildings, which can lead to higher occupancy and rents. Although SERE doesn’t explicitly follow an ESG strategy, Jeff says that the benefits of higher ESG scores are measurable, and paying attention to detail in this area is something the manager is very well-resourced to do. With modest gearing and a covered dividend, SERE’s discount at the time of writing of c. 36% is wide compared to UK equivalent REITs and we think it could perform very well in a recovery scenario for European property.