Schroder European Real Estate 16 September 2022

Schroder European Real Estate (SERE) is a high-yielding REIT which invests in the economically strongest countries and cities in continental Europe. It is the only closed-ended generalist property trust focussed on Europe, potentially offering diversification to investors with UK property exposure.

SERE is managed by Jeff O’Dwyer. The ‘top-down’ strategy is to invest in cities that will generate faster GDP, population and employment growth. At the micro level, the strategy is to use local specialist expertise to identify sub-markets that will benefit from transport infrastructure improvements, supply constraints, competing demands for uses and assets that are leased off affordable and sustainable rents. This should result in better liquidity and increased occupational demand for the assets and drive higher rental growth, occupancy and property valuations. As discussed under Portfolio, the trust is currently biased towards growth cities in Germany, France and the Netherlands, where Schroders have the strongest local expertise.

SERE’s board has maintained a dividend through the pandemic. The initial 50% cut was re-instated within a year, given the asset rent collection and value performance. Based on current share price (94p as at 13 September 2022), the yield is 6.8%, which is high relative to the UK direct property trusts. Maintaining the dividend has been achieved partly through the forward-funded refurbishment and sale of Paris B-B which has delivered a significant capital gain for the trust. In addition, this has provided for the payment of three special dividends totalling 9.6 euro cents. The ordinary dividend is currently c.70% covered by rental income (see Dividend). Risk aversion in markets has seen SERE’s Discount widen out to c.23%, at the time of writing.

SERE has net gearing of 29% on an LTV basis (19% net of cash), as at 30/06/2022. A significant proportion needs to be rolled over in 2023, with the majority of the rest in 2024. This is likely to see the cost of debt rise over the period, given the rates environment.

SERE offers interesting diversification for UK property investors. It may also be a long-term alternative for investors who would otherwise take exclusively UK property exposure. The continental European market is larger and more diverse than the UK’s, while benefitting from some of the same structural trends such as the growing importance of logistics and ESG. The income from the portfolio should provide a strong inflation hedge given the levels of annual indexation, more so than for a UK property portfolio. For a team with the resources of Schroders, there is a broad palette to play with. We think the successful forward-funded refurbishment and sale of the Paris Boulange-Billancourt (Paris B-B) development really shows the advantage of Schroders’ scale, breadth of expertise and risk management. This was a sizeable project, generating a pre-tax capital gain of c. 40% on cost, culminating in strong NAV returns to the trust when the property market was under pressure from COVID (see Performance).

It is hard to get excited about the immediate future for the property market – like the equity market. Clearly, a recession is looming, with an energy crisis this winter. The only questions are the scale and variability of the effects across different countries. SERE has a number of defensive qualities which could be helpful: it is focussed on strong countries and cities, has relatively low gearing and the manager has significant cash to put to work if or when the market sells off. Additionally, all of its rental income is inflation-linked due to the underlying rent reviews. This will be a busy period for Jeff though: gearing needs to be rearranged at higher rates, while the dividend needs to be restored, all in a weak, potentially recessionary market.