Cromwell European REIT (CEREIT) is the largest pan-European REIT listed on Singapore Exchange (SGX). It has around 85% exposure to Western Europe and the Nordics, and is 51% weighted to the logistics/light industrial sector. CEREIT’s EUR2.4 billion ($3.6 billion) portfolio comprises more than 110 predominantly freehold properties in or close to major gateway cities in 10 European countries, the Netherlands, Italy, France, Poland, Germany, Finland, Denmark, Slovakia, the Czech Republic and the UK. Its sponsor, Cromwell Property Group, is a real estate investor and manager with operations in 15 countries and listed in Australia.
1. What are the key takeaways from CEREIT’s 1H2023 results?
CEREIT delivered a resilient set of 1H2023 results, despite weaker macro fundamentals and tight credit markets. We believe that there are two points for investors to take confidence in:
i. Distribution per unit (DPU) is still resilient:
• Overall portfolio occupancy is more than 95%, with like-for-like logistics/light industrial net property income (NPI) up 8.7% and almost enough income growth to offset the rise in interest costs. • CEREIT’s DPU of EUR7.790 cents annualises to around 10% yield at today’s unit price, well above the sector average.
ii. Balance sheet is in good shape:
• We were able to divest EUR135 million worth of assets at a 5.4% premium to valuation and keep gearing below 40%, despite the modest drop in valuations. Net asset value (NAV) is still very high at EUR2.30 per unit compared to CEREIT’s unit price.
• With our recent refinancing, we have EUR500 million of ample headroom now to the Monetary Authority of Singapore (MAS) limits and new loan covenants of 50%. We have no debt facility expiring until November 2025.
2. How does CEREIT plan to bring in additional income and create more value for unitholders?
Three main factors are key to CEREIT’s long-term value creation. First, pivot to logistics. CEREIT embarked on its pivot to logistics back in 2020. As of today, CEREIT has reached an overall 51% majority weighting to the light industrial/ logistics sector which provides higher income growth on the back of e-commerce growth and onshoring of the supply chain, with leading industrial S-REITs trade on premiums to office S-REITs.
Next, development pipeline. CEREIT’s portfolio includes a EUR250 million mid-term development pipeline, rejuvenating and expanding older assets and capturing the green premium evident in Europe. These developments are expected to be accretive on their completion, with our Milan Nervesa 21’s 10,000 sq m office redevelopment on track for completion in 1H2024 and start contributing income.
Third, resuming acquisitions. With over 200 people experienced, on-the-ground team across Europe, we are well-placed to take advantage of our competitive position when markets stabilise and we are able to resume acquisitions. For now, the board has adopted a more cautious stance on capital allocation until the cycle turns, maintaining a gearing policy range of 35%–40%, with an estimated EUR500 million buffer to the regulatory gearing limits of 50%.
3. Elaborate on CEREIT’s recent capital management initiatives.
We recently completed two sustainability-linked refinancings totaling EUR322.5 million with higher loanto-value (LTV) covenants of 50%, leaving CEREIT with no debt expiring until November 2025. The first is a new five-year revolving credit facility (RCF) for an aggregate amount of EUR165 million. The signing of this RCF follows the recent full repayment of the existing facility. Next, we have a new four-year loan facility of EUR157.5 million to refinance the last of the FY2024 debt. As of July 31, 94% of debt is fixed/ hedged for an average of 2.3 years, largely minimising the risk to CEREIT from any further rate increases over the next 1–2 years. We remain committed to maintaining CEREIT’s investment-grade credit rating of at least BBB- with a stable outlook.
4. Is there room to increase distributions to unitholders?
We retain a conservative approach towards the use of proceeds from divestments in this period of slowing economic growth and an environment of higher interest rates. Our current priorities are to keep gearing below 40% and to achieve the most cost-efficient funding for redevelopments. We are on track to reach around EUR200 million in divestments in FY2023, halfway through the announced around EUR400 million divestment programme over the next 2–3 years. There is a short-term negative DPU impact from deleveraging, but this is preferable to a more dilutive equity recapitalisation that other S-REITs have undertaken.
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With over EUR21 million of realised capital gains, NAV is preserved, with these gains available for future distribution when conditions are more conducive. Over the medium term, we expect higher NPI growth from logistics, Grade-A offices and the development pipeline. The negative impact from rising rates should subside, placing CEREIT on a more DPU-sustainable footing.
5. What are some key takeaways from CEREIT’s June 2023 property valuations?
CEREIT’s June 2023 portfolio independent valuations declined by a modest 1.6% compared to December 2022 levels, demonstrating the resilience of CEREIT’s portfolio in the face of weaker macro fundamentals. Valuations were supported by active leasing and renewals of over 30% of the portfolio and sustained a high level of positive rent reversions and market rent growth in the last 18 months, which largely offset the rise in caprates.
Our portfolio’s relatively higher initial yield of 5.9% provided a valuation cushion well above the rise in interest rates, relative to the much lower European prime office and logistics yields of around 3%, which have risen around 100 basis points (bps) this cycle.
6. Tell us more about the leasing market in Europe. What are tenant-customers looking for?
In the European logistics sector, leasing activity continued to be strong, supported by e-commerce and supply chain investments, in particular, the onshoring of light industrials back into Europe. Warehouse rents continued to rise, albeit at a slower pace this year, most recently 4% on average as compared to the previous six months as occupiers are increasingly cost-conscious and impacted by inflation. Vacancy rates continue to remain at a record low of 2.3% across CEREIT’s logistics markets.
Grade-A office vacancy in CEREIT’s key office markets is similarly low at 3.5%. The lack of quality green and energy office space continues to underpin office market rental growth. Overall, the vacancy of office markets is still a credible 8.8%, slightly impacted by the recent economic slowdown and emerging impact of working from home.
7. The REIT has been repositioning itself in recent years with the divestment of non-core assets. Tell us more about your strategy and mid-to-long term plans.
With CEREIT’s current relatively high cost of capital over the past 18 months, we embarked on accelerating our divestment programme to fund the accretive development pipeline. Of the current portfolio, 51% is now effectively light industrial and logistics (up from around 46% when we announced the strategy), including those which are earmarked for development such as the recently completed Lovosice ONE Industrial Park in the Czech Republic and the longer-term 10ha potential redevelopment of Parc Des Docks in Paris.
Another 22% of the portfolio is considered Grade-A offices, predominantly in the core Dutch markets. There is another 13% of older but well-located office assets that are in various stages of major upgrades or redevelopments, such as Nervesa 21 in Milan, which is on track to be completed in 1H2024 and start contributing income.
The near-term earnings, however, may be impacted due to the 1–2 years of time lag from the divestment of yielding assets to fund development projects, before the higher yield on costs and development profits contribute to the bottomline.
Ultimately, we envision CEREIT’s long-term portfolio to be of enhanced quality, future-proofed and relevant for tenant space needs, targeting an asset class split of a 60:40 ratio between logistics and Grade-A offices. If CEREIT’s cost of capital improves, then acquisitions may also be considered down the track. Overall, the number of assets should decline, improving operating efficiencies as well.
8. How are you managing the impact of the current volatilities in the macro environment?
CEREIT is executing our investment strategy and maintaining active asset and capital management in this challenging environment.
Some highlights from our mid-year scorecard:
• CEREIT’s resilient portfolio only saw modest decline in latest valuations and successful asset sales have kept aggregate leverage at 39.5% (as at July 31 following its full RCF repayment with Piazza Affari 2 proceeds), although asset values are declining globally, and interest rates are still rising.
• CEREIT’s all-in interest rate in 1H2023 was higher at 2.85%, compared to 2.38% as at Dec 31, 2022, but the increase is still less than one-third of the move in 3M Euribor, which is now 3.74%.
• CEREIT’s +5.9% rental reversions in 1H2023 was 300 bps higher versus the prior corresponding period. It continues to benefit from inflation indexation flowing to NPI as core inflation remains high (despite falling headline rates).
• CEREIT’s pivot to light industrial and logistics continues (around 51% of portfolio) as secular trends such as WFH, ESG and energy efficiencies, are affecting office space demand.
9. What are the most significant ESG risks and opportunities faced by the REIT and how is it managing them?
CEREIT is now one of only three S-REITs with a leading MSCI ESG “AA” rating in Singapore and is in the lowest ESG risk score category, according to Morningstar Sustainalytics, putting it in a lead position among more than 450 REITs rated worldwide. We achieved this after five years of continued improvement in reporting and asset management initiatives. Sustainability and ESG are no longer “nice-to-haves” but “must-haves”, as ESG credentials increasingly become barriers to entry for both access to capital markets and income resilience due to evolving customer needs.
On the capital markets side, our leading ESG reporting practices and ratings allowed us to introduce green financing framework two years ago. Including the recently refinanced term loan facility, we have now completed approximately EUR575 million in sustainability-linked loan facilities over the last two years, which allow us to benefit from interest cost saving that are linked to sustainability metrics.
On the income resilience side, there is growing demand for quality Grade-A office properties with green certifications, as occupiers are taking less space but are paying more for it. We tap into this opportunity through our Nervesa 21 redevelopment, which is already achieving well over EUR350 per sq m of rent, way above the initial targets. This highlights the limited options for tenants seeking quality Grade-A offices with green certifications, as well as the opportunities that CEREIT can take advantage of.
10. Why should investors take a closer look at CEREIT?
First, CEREIT’s portfolio is now effectively 51% weighted to the light industrial/logistics sector which provides higher income growth and largely offsets the impact from higher interest rates. CEREIT’s DPU of EUR7.790 cents annualises to around 10% yield and 35% discount to NAV per unit at today’s price.
Second, CEREIT has a conservative capital structure with leverage at 39.5%, which is within the Board policy range of 35%–40% and with around EUR500 million headroom to MAS limits without an expensive equity raise, at a time where investors are also seeking S-REITs with conservative balance sheets.
Third, we are focusing on delivering on organic opportunities and prioritising unlocking value from CEREIT’s existing portfolio. The EUR250+ million medium-term office and logistics development and asset enhancement pipeline, involving key properties in Milan, Rome and the Czech Republic, is progressing well.
Jihye Lee is associate director, research, at the Singapore Exchange