Investment Trusts

How to invest in Europe’s winning cities

Jeff O’Dwyer, manager of the Schroder European Real Estate Investment Trust, explains why Berlin, Hamburg, Frankfurt, Stuttgart and Paris are “winning cities”.

08 Mar 2019

Jeff O'Dwyer

Jeff O'Dwyer

European Investment Manager

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With the UK’s deadline to leave the European Union fast approaching and a deal yet to be agreed, investors may be tempted to look further afield for income and diversification opportunities.

In contrast to the UK’s commercial property market, which is shrouded by Brexit uncertainty, a number of cities across Europe currently offer investors exciting growth prospects.

Jeff O’Dwyer, manager of the Schroder European Real Estate Investment Trust, describes Berlin, Hamburg, Frankfurt, Stuttgart and Paris as “winning cities”. He believes they have the potential to grow 25 per cent to 35 per cent faster than their domestic economies, buoyed by a number of positive dynamics. These include infrastructure improvements, employment growth, urbanisation and tourism. 

What’s more, a number of these cities are already benefiting from banks moving teams out of London as a result of Brexit.

“We have around 80 per cent allocated to the top tier growth regions,” Mr O’Dwyer says.

Schroder European Real Estate is the only UK-listed real estate investment trust which offers investors access to a diversified portfolio of commercial property investments across Europe. Investors also receive inflation-linked income because all of the leases in the portfolio are index-linked.

 “We are diversified in terms of sectors, cities and tenants. We have close to 100 tenants, an unexpired least term of around 6.5 years and 97 per cent occupancy, so there is a good basis there for maintaining our income profile,” explains Mr O’Dwyer.

The investment trust, which has a gross asset value of approximately €250 million, draws on the expertise of local teams across Schroder Real Estate Investment Management. They focus on locations where rents are low and sustainable, where there is competing demand for uses and supply is constrained.

Once assets are purchased at attractive valuations, the team seeks to add value through asset management. For example, by investing in the properties to increase the amount of rent they can receive per square metre.

A good example is Mariendorf, a retail warehouse based in Berlin which is let to DIY operator Hornbach. The fund manager describes it as one of his favourite assets in the portfolio. The property was purchased with a lease term of a little over eight years and a net initial yield of 6.2 per cent. This equates to the net income the tenant pays (minus costs that accompany the running of the property) divided by the gross price.

“The big attraction here is that we are sitting on four hectares of land. Surrounding this asset is medium density residential and offices. We know we can add value once we get vacant possession. 

“The tenant may stay and we are happy to take the 6.2 per cent net initial yield, but the longer term play is to work on planning and try to put this site to stronger use,” Mr O’Dwyer explains. 

The fund manager adds that the team’s overall intention is to “sweat the assets, not the balance sheet”. This helps to explain why leverage stands at 26 per cent loan-to-value, below the 35 per cent limit. 

Over the past 12 months, the team has reduced exposure to retail and built an allocation to industrial warehouses - a sector that offers attractive growth prospects. Exposure to this sector currently stands at 13 per cent and Mr O’Dwyer expects it to increase to 19 per cent with the conclusion of a French logistics asset that is in exclusivity.

Post the addition of the French logistics investment,  Office represents the largest allocation at 46 per cent, while retail stands at 27 per cent of the portfolio. In spite of the negative headlines concerning the retail sector, the team continues to identify attractive investment opportunities in this space with the above referenced Berlin investment a good example.

Here, they focus on assets which have points of difference, where there is potential to add value. For example, Mr O’Dwyer likes that the Metromar shopping centre in Seville has entertainment and leisure facilities. A number of asset management initiatives are also under way at this site, including a refurbishment of the centre and the introduction of another leisure specialist, providing trampolining and rock climbing.

Looking ahead, Mr O’Dwyer is confident that the team can continue to grow Schroder European Real Estate’s dividend by actively managing the assets and targeting markets where they identify superior growth prospects. 

“European real estate fundamentals remain sound. Office rental growth remains above trend, driven by growth in office employment and record low vacancy rates. In addition, we haven’t seen an imbalance on the supply side.

“We have put together a robust portfolio which can deliver a sustainable income. It is also diversified and exposed to cities we think will grow faster than their domestic economies,” Mr O’Dwyer concludes.