Currently one of my favourite plays on Eurozone equities is a UK listed investment trust from Schroders. It’s called the Schroders European REIT and in my view, it’s the perfect vehicle for income investor’s looking to make an investment in the resurgent Eurozone.
My rationale is very simple for holding the fund.
First I think much of the UK property market is over priced.
Next up I think key cities in the Eurozone look much more interesting.
Third I think Schroders is a sensible house to bet on, especially as they’ve been running property money in Europe for ages.
The fund’s recent interims underline the investment rationale. The numbers were for the period through to March 31st and showed that the net asset value of the fund was at 131.5 euro cents — equivalent to 11p a share — which is an increase of c.1.0% since 30 September. Some of the properties in the fund have increased in value (worth about 3.4c to NAV) although there have been some transaction costs as the portfolio fills out. Earnings for the fund rose to €2.6m (2.0c) from €1m, reflecting growth in the rent roll from acquisitions.
Crucially the board has declared a second interim dividend of 1.2c, representing a 20% increase over the quarter, taking the total declared for H1 to 2.2c, representing an annualised yield of 3.5%. The company is targeting a fully covered dividend yield on full investment of 5.5% (based on euro equivalent IPO issue price).
Looking at the portfolio of eight properties in the portfolio, they’re concentrated in tier one growth cities such as Hamburg, Paris and Stuttgart. Collectively they are valued at €182.7m, an increase of 2.5% in the period. In total there has been a 6.7% uplift when compared to the purchase price.
The portfolio is 100% let with the average length to expiry for the leases running at 7.1 years. The debt supporting the fund is also dirt cheap, and conservatively structured: total facilities amount to €60.4m, with an average interest cost of 1.3%. The loan to value ratio (the ratio between actual assets and loans) stands at 26%.
The underlying yield on the properties overall is running at an average of 6.1%. Investment trust analysts covering the fund at Numis also observe that “rents are growing at a faster rate than for many years” with a current pipeline of c.€115m of assets, at an average yield of 6.5%.
In fact just before these numbers were released the fund also disclosed a new deal, which involves buying the Metromar shopping centre in Seville, Spain’s fourth largest city. The centre cost c.€52.5m to buy and is part owned by SERE and another Schroders private fund. The net initial yield on the property is 6.2% — the cost of the property is being part funded by debt (€23.4m) which is costing a fixed interest rate of 1.76% pa. Tenants in this shopping centre (50 in all) include top tier names such as Zara, Mango, Sfer, H&M, Pull & Bear, Stradivarius, Bershka and Cortefiel — there’s also a big cinema and restaurants. Schroder’s reports that Sales growth at the centre has been robust over the past three years rising 4% in 2014, 8% in 2015 and 4% in 2016, reflecting the quality of the location and tenant base.
So, overall the fund is very close to being fully invested — there might be another £30m or so of extra capacity left if loans are included. It’s also delivering on its promises, namely investing in solid properties in growth cities in Europe, conservatively financed, and well run. With the current share price at 108.8p, the fund is trading at a small discount of around 2.5%, which compares with an average premium of 6% for most UK REITs which in turn produce an average yield of just 4.5%.
If all that wasn’t enough I’d simply refer to a note out today from Numis which further explains the investment logic. Here it is in summary form.
Schroder European Real Estate IT (SERE) offers unique exposure, via a London listed vehicle, to a portfolio of directly owned European (ex UK) real estate assets. The manager continues to make progress on its IPO target to deliver a 5.5% Euro yield, underpinned by high quality assets which fit the stated “European Growth City Strategy”, where both GDP growth and property returns are expected to outperform national averages. The portfolio of assets is performing well (valued +6.7% ahead of acqn. price) and is expected to benefit further from structural trends, infrastructure improvement and economic recovery. Moreover, we would expect the manager’s access to a growing pipeline of potential investments and attractively priced, long-term debt to boost returns. We suggest the current share price represents an attractive entry point for exposure to a growing income yield, and offers value relative to the valuation of domestically listed European REITs. It also provides diversification from the slowing UK real estate market.
To access the full research note please click here (17 pages): Download SERE Update June 2017.pdf
- Focused property strategy: SERE invests in cities/regions of Western Europe (ex UK) characterised by large, liquid real estate markets offering superior growth potential. Examples include Amsterdam, Berlin, Hamburg, Madrid, Munich, Paris, Stockholm and Stuttgart. The manager will invest across all main sectors, targeting a portfolio weighted c.70% to Core/Core Plus assets with strong fundamentals and sustainable income profiles. The balance will be value-add assets, including shorter income, or assets with potential for alternative use or repositioning.
- Conservative gearing: SERE seeks to enhance property returns with a relatively modest level of gearing (35% target LTV). Debt is secured against individual properties, or groups of assets, rather than portfolio-wide, enabling the manager to apply the most appropriate level of gearing for each asset. To date, SERE has secured four separate facilities totalling €60.4m, including three from the German Pfandbrief market, which is known for its stringent lending criteria. €74m of assets are currently ungeared. The debt book offers a good balance of long-term (7.3 years), low-cost debt (blended all in the cost of 1.3%) which is earnings accretive. The current LTV of 26%, results in geared property returns (pre fund costs) of over 8%.
- Yield-biased target return: SERE targets a fully-covered, Euro yield of 5.5% (7.5c based on Euro equiv. issue price of 137c), including target gearing of 35%. Dividends are declared in Euros, and paid quarterly, with UK shareholders receiving payments in Sterling by default, with the option to elect to receive in Euros. Since IPO, SERE has paid 3.9c in dividends. Based on the most recent quarterly distribution, the annualised yield is 3.7% (4.8c), although we would expect this to rise to c.4.6% (6.0c) from the end of Q3 2017, incorporating a full quarter of income received from the Metromar Centre in Seville. With c.€30m of capital to deploy and a strong investment pipeline, we expect further progress towards the annual target in the near term.