Results analysis: Starwood European Real Estate Finance

• Starwood European Real Estate Finance (SWEF) has reported an NAV total return of 6.3% for the year ending 31/12/2020 and a share price total return of -7.5%. Excluding dividends paid, the NAV per share rose 0.9% to 104.18p.
• Last year’s (2020) targeted dividend of 6.5p per share was paid, covered 90% by income earned. As announced in July 2020 as a result of the falling interest rate environment and its effect on the yields achieved on loans, the target for 2021 is 5.5p per share, paid quarterly.  The premium over base rates remains high relative to recent history at these levels. 
• No impairments were taken to the loan book, despite the impact of the pandemic. However, six loans, 35.3% of the portfolio, were classified as stage 2 last June, meaning credit risks were deemed to have increased significantly. These are predominantly in the retail and hospitality sectors.
• All loans have paid all scheduled interest and principal in full and on time.

Kepler View

The robust results from Starwood European Real Estate Finance (SWEF) after such a tumultuous year underline the potential benefits from investing in real estate via debt rather than equity. The majority of SWEF’s loan book is in areas which have performed strongly from an income and valuation perspective.  However, SWEF does have significant exposure to hospitality (35.7%) and retail (12.9%), two sectors of the real estate market which have been forced out of trading for much of the past 12 months. Yet while the equity in these sectors has seen some declines, SWEF’s investment manager, advised by Duncan MacPherson and Lorcain Egan as the investment adviser, has not seen fit to recognise any losses on the loans it has made in these sectors, estimating that while default risks may have increased, as shown by the six loans classified as stage two, there is no current expectation of losses on those loans.

Roughly half the loans by value in the portfolio did see some modification to their terms in 2020 as a result of the impact of COVID-19, but all were neutral to expected returns with no interest deferrals. The investment adviser was able to secure strong structures both as part of the loan origination and through further negotiation with borrowers.  For all operating assets where income has been disrupted, shortfalls and debt service have been met through existing or new reserves that have in many cases been funded through fresh equity. Their ability to engineer these changes reflects the power that comes from lending to a company rather than owning its equity.

The pandemic is not over, and with infections rising on the continent restrictions are being reimposed in certain countries, SWEF’s borrowers in the hospitality and retail sectors in Spain in particular could see weaker trading, affecting tenant income and valuations, particularly if travel restrictions are retained for the long term. SWEF has recently arranged a full independent valuation of its Spanish retail loan assets. While the valuations are not yet finalized, the indicative results show the LTV on the portfolio as a whole has deteriorated modestly from 61.8% to 63.2% . We note that prior to this valuation the retail exposure has had the highest average LTV in the portfolio of 66.9%.

However, the investment adviser reports encouraging signs of demand for investment in hotel assets both through debt and equity in the first months of 2021 and expects domestic tourism demand for UK hotels to be very high once domestic restrictions are eased in the early summer.

It also reports that while there is generally increased interest in lending from a broad set of investors, the long term theme of balance sheet banks withdrawing from the market continues and increases the scale of the opportunity SWEF was set up to take advantage of and the chance of attractive pricing. At year end, SWEF had unused debt facilities of £106.5m available to fund undrawn commitments of £49.1m and new lending as opportunities arise. Net gearing was just 3.9% of NAV.

Considering the near-term risks, we continue to believe that a double digit discount to NAV is attractive (it is 18.3% as of 25/03/2021) particularly when the forward yield of 6.4% is compared to the average 4.4% yield available on the AIC UK Commercial Property sector.

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