Schroder Real Estate 20 August 2024

Schroder Real Estate Investment Trust (SREI) is a diversified UK commercial property REIT which aims to deliver a mixture of income and capital growth, typically focussing on higher-income assets. In December 2023 shareholders approved changes to the investment objective, adding specific sustainability KPIs, which the manager believes will lead to higher investment returns.

SREI is managed by Nick Montgomery, who has worked on the trust since its IPO in 2004, joining Schroders in 2012 when it took on the management contract, together with his co-manager Bradley Biggins, who joined Schroders in 2014. In the Performance section, we look at the standard NAV and share price performance, but also the underlying property portfolio performance, which has exceeded the relevant benchmark over 1, 3, and 5 years and since inception.

The trust is geared c.37% LTV, higher than the average for its closest comparators, but within the normal range for UK REITS. Gearing is predominantly provided by long-term, low-cost debt with an average maturity of c. 10 years and interest cost of 3.5%. We discuss the effect on long-term performance of gearing in the Performance section.

SREI trades on a c. 24% discount at the time of writing, compared to the Morningstar UK Commercial Property peer group's average of c. 25%. The trust yields c. 7%, compared to its five-year average of c. 6.4% and has a track record of paying a covered Dividend.

Nick and Bradley estimate that there is a significant 'green premium' on the right property assets in the UK, with tenants willing to pay more for energy-efficient buildings and a good environment for employees, and the case study in the Portfolio section is good evidence of this. Whilst some investors remain on the fence or even sceptical of some ESG strategies, in our view, property is one area where the benefits can be quantified straightforwardly, and a direct link to the value of the investment can be drawn. It's clear from the process and scorecard, outlined in the ESG section, that the change in objective for SREI is not based on a newly minted process, and a lot of work has already gone into defining how assets will be assessed, monitored, and improved upon.

At the same time, some investors may now be looking for green shoots for property as an asset class. Valuations fell again in 2023 but the valuation of SREI’s portfolio stabilised in the last quarter of 2023 and into the first quarter of 2024, with the net initial yield, 6.1%, now at a substantial premium to ten-year UK government bonds at c. 3.9%, and with SREI's reversionary yield of 8.4% hinting at income growth in the coming years. SREI's c. 25% discount means that the market is pricing the net initial yield at 8.1%, and this is a spread of over 400bps to ten-year gilts, which is, in our view, the signal for a potential recovery. SREI, a little more geared than many of its diversified peers, mainly with long-term, fixed-rate, low-cost debt, could perform well in such a scenario. In the meantime, the company offers a c. 7% fully covered dividend yield, and the portfolio has one of the highest reversionary yields in the peer group and the newly adopted strategy could provide additional impetus to income growth.