Results analysis: Starwood European Real Estate Finance

• Starwood European Real Estate Finance (SWEF) has reported a strong 11.1% share price total return for the year ending 31/12/2022. During the year SWEF paid dividends of 5.5p in four equal quarterly installments as targeted and the board states it expects to continue to pay at this level going forward.
• SWEF lends against European real estate, and despite the uncertainties of the pandemic, SWEF has performed robustly and has reported no writedowns in the value of its loans. All loan interest and scheduled amortization payments were paid on time during the year, and the company expects this to continue.
• During the year SWEF committed £90.8 million to three new loans to borrowers in the UK life sciences, office and hospitality sectors. A further £88m of cash and gearing facilities are available for future investments once commitments are accounted for.
• SWEF’s average loan LTV levels remained stable, with a portfolio level LTV of 61.9% at year-end, comfortably below the typical expected upper limit of 75%.
• The discount narrowed during the year as sentiment to commercial real estate continued to improve, contributing to shareholder returns. At the end of the year the discount was 8.8%. At the time of writing the discount is 6.9% (as of 28/03/2022).
• The board has the ability to buy back shares and typically aims to do so when the discount is wider than 7.5%, although it has not done so since January 2021. However, the board has decided to put forward a realisation vote to shareholders no later than 28 February 2023, and engage with shareholders on this before the end of 2022, which could give investors more comfort about the likely future course of the discount.  
• Chairman John Whittle highlighted, “the unique portfolio resilience that is clear to see in the strength of these results…. I believe that this excellent result is due both to the evident rigorous underwriting of borrowers/sponsors and the very diligent ongoing portfolio management by our investment adviser and investment manager.”

Kepler View

Starwood European Real Estate Finance's (SWEF) performance through the volatility of the pandemic has been rock solid. No interest payments have been missed and no covenants were breached, with managers recognising no impairments despite the severe impact of the pandemic on some of the tenants of the underlying properties, especially in the retail and leisure sectors. With the peak phase of the pandemic behind us and economies open, the managers report one of their strongest pipelines of potential opportunities in a dislocated market and have plenty of resources to take advantage.

The defensiveness demonstrated by the portfolio could be highly attractive in 2022 as the European economy struggles with the impact of inflationary pressures exacerbated by the war in Ukraine. Equity and bond markets have been volatile year-to-date, and the prospect of significant interest rate hikes as a response to inflation is another risk to bear in mind. This is particularly germane to bond investors, as fixed interest securities would see hit to their capital values with rising interest rates. However, 78% of SWEF’s portfolio is in floating rate loans, meaning the majority of the income received will see a pass through from rate hikes and the duration is very low – in fact not being marked to market means there will be no negative impact from rising rates on the carrying values of the loans at all.

SWEF’s dividend yield of 5.7% (as of 28/03/2022) compares to the 4.8% offered on average by the generalist UK commercial property equity trusts. As for conventional bonds, after a sell-off in spreads this year, the ICE BofA Euro High Yield Index is yielding 4.4%. While it has more capital appreciation potential, it also has a much higher duration and a greater likelihood of experiencing loss. The current discount of 6.9% as of 28/03/2022 could prove to be a good entry point to a long-term opportunity given this seems to be driven by general risk aversion following the Russian invasion of Ukraine rather than any factor more likely to harm the operation or valuation of the portfolio. The realisation vote should also provide additional support to the discount as it draws nearer, while the majority floating rate portfolio positions SWEF very well in the current rising rate environment.

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