8% yield on European commercial property Schroder European Real Estate

SERE offers a 8% yield on European commercial property’…by Alan Ray

Overview

Schroder European Real Estate (SERE) is a diversified REIT focussing on European commercial property. The investment strategy centres around ‘winning cities’ and regions in Europe, and the management team takes a great deal of care to understand factors specific to each local market, for example, local transport infrastructure, and an understanding of possible alternative uses as both a risk mitigator and a source of potentially higher returns. For example, the manager notes the possibility that SERE’s largest tenant, telecom company KPN, will give notice on its lease expiring at the end of 2026, giving the team the opportunity to look at a range of options, including a new tenant or seeking an alternative, higher-value use. In this scenario, SERE’s role would most likely be to secure the relevant permissions and sell the asset to a developer, releasing cash for recycling into assets with a longer-term income profile.

SERE currently yields 7.9%, with a c. 36% discount contributing to the higher yield. SERE’s portfolio is 100% exposed to some form of local indexation (c. 80% annual), and over the last few years of higher inflation, these contracts have held true, contributing to SERE’s fully covered dividend.

SERE’s net gearing has reduced from 24% to 19% LTV following two disposals in the last year, and there is available cash of c. €25m. The next debt refinancing is due in June 2026, and manager Jeff O’Dwyer feels that, in general, banks remain constructive in lending against good quality assets and notes that the all-in cost of debt is currently just under 4%, compared to a portfolio yield of c. 6%, maintaining the all-important carry between interest cost and income.

Analyst’s View

One of the key elements of SERE’s management strategy is to seek assets where there is a strong case for alternative uses. Recently, in the UK-focussed REIT space, we have seen several ‘alternative use’ transactions where assets have been sold once relevant change of use permission is acquired, in order to recycle into assets that generate more income and or value. As we touch on in the Portfolio section, SERE has this potential across several assets, both in the short and long term. SERE’s largest asset in terms of income, a data centre, office, and industrial complex, which contributes 18% of income, is valued in anticipation of its largest tenant, telecoms company KPN, leaving at the end of the lease in December 2026, and in our view, SERE’s c. 36% discount is the market’s way of saying it can’t look through this event and see the potential on the other side. A successful process to find a new tenant, or a solution that involves a change of use and a sale, could therefore be very positive. This is a large site of several hectares, so the possibility of change to residential would potentially be very attractive to developers and allow SERE to exit. Situations like this are what active management in real estate is all about, and manager Jeff O’Dwyer is supported by c. 200 property investment professionals and thus well equipped to deal with the complexities.

Beyond this short-term active management challenge, SERE has reduced net gearing to a modest 19% LTV and has cash resources available to fund share buybacks at the current very wide discount. Although clearly there are risks, the recovery potential is now less about macro factors than it was two years ago and has swung towards SERE’s experienced management team.

Bull

• Exceptionally wide 37% discount to net asset value
• Low gearing with net cash available for investment or share buybacks
• Successful active management could significantly alter the market’s perception of risk

Bear

• Near-term risk from largest tenant may impact dividend cover
• Although seen as unlikely, a negative judgement from French tax authorities could be significant
• SERE’s market cap is less than £100m, which equates to relatively low secondary market liquidity

Read the latest research note re SERE here >

_Disclaimer

_{Disclosure – Non-Independent Marketing Communication}

_{This is a non-independent marketing communication commissioned by Schroder European Real Estate. 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.}