Alan Ray
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Updated 24 Jun 2024
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This is a non-independent marketing communication commissioned by Schroder Investment Management. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.

  • Over the six months to 31/03/2024, Schroder European Real Estate (SERE) produced an NAV total return of -1.3%. The main contributors to this were a 4.6cps reduction in property valuations, and 3.2cps of rental income. After paying dividends of c. 3.0cps, the closing NAV per share was 123.6cps, and overall NAV was €165.3m.
  • The trust paid two quarterly dividends of 1.48cps, for a total of 2.96cps. Dividends were 109% covered by EPRA earnings. SERE currently yields c. 9% (as at 20/06/2024). SERE's EPRA earnings increased 3% to €4.3 million compared to the previous six months, primarily due to rental growth offsetting the impact of higher interest costs.
  • The decline in capital values was driven by a continuation of yield expansion for property valuations. Over 12 months the portfolio produced a total return of 0.6%, and 3.1% p.a. over three years and 6.2% p.a. over five years.
  • The strongest returns over the period came from SERE's industrials assets, c. 30% of the portfolio, with the Venray asset producing a total return of +4.9%, Nantes +4.1% and Rennes +3.6%. Conversely the car showroom in Cannes produced a total return of -7.0%, while other German and Dutch office and industrial assets saw small negative total returns as capital value declines weighed slightly more heavily than the income returns generated.
  • The portfolio void rate was 4% of estimated rental value and the portfolio weighted average lease length is 3.7 years. 80% of rental income is subject to annual indexation with the remaining 20% linked to a hurdle (typically 10%).
  • SERE has net gearing of c. 24% LTV and no further debt expiries until June 2026 and a low average interest cost of 3.2%. There is c. €26m of cash which gives management the flexibility to allocate capital on earnings-enhancing initiatives on the existing portfolio or to make further acquisitions.
  • Over the period, SERE's discount widened slightly from c. 38% to c. 40%, and while its direct peer group average only consists of SERE and one other trust, for reference the Morningstar UK Commercial Property peer group average discount is c. 26%T.
  • Sir Julian Berney Bt., chair, said: "Despite macroeconomic headwinds, the resilience of the portfolio together, with local sector specialist teams, has delivered rental growth, largely offsetting the impact of higher interest rates. Management has successfully completed the recent refinancings which, combined with significant cash reserves, has further strengthened the balance sheet. The company provides a compelling and differentiated investment proposition compared to our UK-listed peers. We have the flexibility to grow earnings through exposure to strongly performing assets in higher growth European cities, as well as executing on value-enhancing asset management opportunities."

Kepler View

Post results the ECB cut interest rates for the first time in five years, so it's fair to ask how Schroder European Real Estate’s (SERE) yield stacks up against relevant bond yields. SERE's dividend yield is hovering around its lifetime high in absolute terms, c. 8%, and the spread over 10-year German government bonds, yielding c. 2.5%, is therefore c. 5.5 percentage points, above the five-year average. This covers the pandemic period and so arguably the average is skewed higher than it might otherwise be. Either way, SERE's dividend yield, which is fully covered, is in the territory where, in our view, a discount recovery looks plausible with further rate cuts.

Underlying SERE's dividend yield of c. 8.0%, the net initial yield on the portfolio is now 6.8%, and so again, a significant spread, 4.3 percentage points, over the same government bond yield. SERE has continued to see rental growth through the higher interest rate cycle, with almost all leases linked to inflation in some form, including 80% on annual inflation indexation, and in the last six months SERE saw EPRA earnings grow by 4%. During the period when inflation was running much higher, and one might reasonably have asked how strong indexation really was, the team continued to put through inflation-linked rental increases, demonstrating the strength of the portfolio.

In our view the final piece in the puzzle for investors will be a stabilisation of capital values. SERE saw a 3% drop in the portfolio valuation over the six months, with the positive total return made up by the income return. With the market currently pricing further rate cuts this year, this point may not be too far away, which puts the spotlight firmly on SERE's discount to net asset value of c. 40%, a level that is as wide as it has ever been aside from some brief one-day volatility during the pandemic, as the chart below illustrates. SERE's net gearing, 24% LTV, (32% of net assets), is about average for listed REITs and there are no further refinancings until 2026. There is also enough cash for the team to consider either earnings-enhancing initiatives within the existing portfolio, or to acquire further assets, which could further enhance earnings. Thus, we think the recovery potential is strong and the macro factors that could drive that are starting to fall into place.

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Source: Morningstar

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