Starwood European Real Estate Finance (SWEF) lends against commercial property in Europe and the UK, aiming to find attractive investments from a risk/reward perspective in areas of the market that are less well served by the bank market (which has remained constrained in the post-global financial crisis environment).
SWEF is managed by a subsidiary of Starwood Capital Group, one of the world’s largest real-estate investors, which brings a huge origination platform, specialist knowledge and strong industry relationships. These are an advantage in identifying inefficiencies in the market to provide value-add lending solutions to financially strong borrowers (mainly in the UK, Spain and Ireland).
SWEF pays a 6.5p dividend quarterly, to be rebased to 5.5p from 2021 due to the continued decline in interest rates, off which SWEF’s lending is priced. On the current share price, this would amount to a yield of 6.4%. As it invests in senior and subordinated debt, SWEF’s interest sits high up the capital structure, with less exposure to market values than the equity REITs do. Nevertheless, SWEF has fallen into a discount of 15.5%, wider than the 13% average discount of the equity REITs in the AIC UK Commercial Property sector. From 10 August Jefferies has been employed as an independent buyback agent with discretion as to timing until 31 December 2020.
Despite the significant exposure to the hospitality sector, SWEF has suffered no impairments in the crisis so far and no missed interest payments. The loan to value on the portfolio is just 63%, giving a substantial equity cushion, and SWEF has modest gearing at the portfolio level of just 3.5% of NAV.
In our view SWEF is an attractive way to invest in real estate for a high income with reduced risk to capital values, although with correspondingly limited prospects for capital growth. Even after the rebasing of the dividend, we think the prospective returns are attractive both in absolute terms and relative to likely returns in commercial-property equity. The future for commercial-property equity investors looks problematic, given the impact of the pandemic and lockdowns on mobility and commerce. Capital values are therefore likely to be weak in the coming months and years, while dividend cuts have been generally quite significant across the sector already, with the potential for more to come. Investing higher up the capital structure seems attractive in the current environment, as does taking commercial-property exposure without taking exposure to the operational performance of the tenants.
We think the discount is pricing in the fear of impairments, and reflects nervousness about the exposure to the hospitality industry in particular. However, we note the conservative starting loan to value of 63%, as well as the fact there have been no missed interest payments so far and no amendments made to interest-payment schedules. Although we recognise the full impact of the pandemic is yet to be clear, we don’t see any indication yet that impairments are on the horizon (indeed the managers are confident there will be none), and we think the discount is inappropriately pricing in equity-like risk.
|Scale and strength of the Starwood origination platform allow access to a large, diverse pipeline
||High reinvestment risk, requiring stream of new investments to maintain income
|Modest LTV on the underlying loans reduces risk of impairments
||Further lockdowns or movement restrictions could lead to pressure on hospitality and retail borrowers, while operating performance will remain under pressure for some months
|Loans are high up the capital structure, and so are less sensitive to market valuations than equities are
||Concentrated portfolio increases risk if one of the largest loans is impaired|