Cromwell European REIT (CEREIT): High-Quality Assets at a Discount

Cromwell European REIT (CEREIT): High-Quality Assets at a Discount

Overview:

Cromwell European Real Estate Investment Trust (CEREIT) is a Singapore-listed real estate investment trust (S-REIT) that focuses on investing in income-generating commercial real estate across Europe. The portfolio consists of 107 properties, primarily freehold, strategically located in major gateway cities in countries such as the Netherlands, France, Italy, Germany, Poland, Denmark, the Czech Republic, Slovakia, Finland, and the United Kingdom. CEREIT’s assets are divided between light industrial/logistics (L&I) properties (54%) and office spaces (44%).

As of June 30, 2024, CEREIT is repositioning its portfolio to capitalize on structural tailwinds in the L&I sector while maintaining a diversified tenant mix with long weighted average lease expiries (WALE). Despite the challenges from rising interest rates and asset divestments, CEREIT’s high-quality assets and strategic pivot towards logistics have created long-term growth potential.

Recommendation and Target Price:

• Recommendation: BUY
• Target Price: EUR 1.87
• Current Price: EUR 1.53
• Potential Upside: +22%
• Broker: OCBC Investment Research
• Date of Recommendation: September 9, 2024

Key Investment Highlights:

1. High-Quality, Green-Certified Assets

CEREIT’s portfolio includes a range of Grade A office properties, many of which are green certified under BREEAM or LEED standards, underscoring the REIT’s commitment to sustainability. Approximately 82% of CEREIT’s office assets are certified, which not only helps attract high-quality tenants but also aligns with the growing trend towards sustainable real estate investments.

Additionally, CEREIT is one of only three S-REITs to have achieved an AA ESG rating from MSCI, positioning the trust well to benefit from the increasing investor focus on environmental, social, and governance (ESG) criteria. CEREIT’s commitment to sustainability also enhances the marketability and long-term value of its assets.

2. Strategic Pivot Towards Light Industrial and Logistics Assets

CEREIT is in the process of rebalancing its portfolio by reducing exposure to office assets and increasing its allocation to light industrial and logistics (L&I) properties. The REIT aims to achieve a 60:40 mix between L&I and office properties, capitalizing on the growing demand for logistics space driven by e-commerce, nearshoring, and just-in-case inventory strategies.

To date, CEREIT has divested approximately EUR 260 million in non-core office assets, part of a broader plan to divest EUR 350 million by FY26. This capital recycling will allow CEREIT to reinvest in higher-growth L&I properties, which are expected to offer more resilient earnings and stronger rental growth potential compared to office properties.

3. Diversified Tenant Mix Reduces Risk

CEREIT boasts a diversified tenant mix that reduces its exposure to any single sector or tenant. As of June 30, 2024, the REIT’s top ten tenants contributed less than 23% of total headline rents, with no single industry or trade sector representing more than 17% of the portfolio. This diversification, combined with a strong WALE of 4.8 years, enhances the resilience of CEREIT’s rental income.

CEREIT’s portfolio is home to 824 tenants, many of which are global multinational companies (MNCs) or government agencies with high credit ratings. The portfolio’s healthy occupancy rates (93.6% overall) and positive rental reversions (5.2% in 1H24) further underscore the stability of its income stream.

4. Positive Rental Reversions Despite Market Challenges

Despite rising interest rates and higher financing costs, CEREIT’s portfolio has continued to achieve positive rental reversions across its office and L&I assets, with rental growth averaging 5.2% in 1H24. Both asset classes are under-rented compared to market rates, indicating further potential for rental growth in the coming years.

CEREIT’s L&I assets are particularly well-positioned to benefit from strong demand for prime logistics space, especially in last-mile locations. The REIT’s logistics assets achieved 4% rent reversions in 1H24, and demand from sectors such as manufacturing and transportation is expected to continue driving rental growth.

5. Asset Divestments and Portfolio Repositioning

CEREIT has outlined a strategy to focus on higher-quality assets by divesting non-core office properties in less resilient markets, such as Finland and Poland. So far, CEREIT has sold EUR 260 million worth of assets, with an additional EUR 90 million of divestments targeted by FY26.

These divestments are part of CEREIT’s broader effort to reposition its portfolio towards L&I properties, which are expected to deliver higher growth and more stable returns. The REIT’s focus on asset enhancement initiatives (AEI) and strategic redevelopments is expected to further boost rental income and occupancy rates over time.

6. Strong Financial Position with Attractive Valuation

At its current price, CEREIT is trading at a 0.69x price-to-book ratio (P/B), which represents a significant discount to its historical average of 0.79x. This valuation is particularly attractive given the quality of CEREIT’s assets, its positive rental growth outlook, and its high distribution yields.

For FY24 and FY25, CEREIT is projected to deliver distribution yields of 9.2% and 9.1%, respectively. Despite the temporary decline in distributions due to divestments and higher interest costs, CEREIT’s long-term growth prospects remain strong, supported by its high-quality assets and ongoing portfolio repositioning.

Valuation and Financial Projections:

Using a dividend discount model (DDM), OCBC Investment Research has derived a fair value estimate of EUR 1.87, implying a potential upside of 22% from the current price. Key assumptions in the DDM include:

• Cost of equity: 8.65%
• Terminal growth rate: 1.50%

CEREIT’s distributable income is expected to decline in the near term due to asset divestments and higher financing costs. However, distributions are projected to recover gradually starting from FY26, as the REIT completes its refinancing and continues to benefit from rental growth in its L&I portfolio.

Financial Highlights (EUR million)

Risks to Consider:

1. Refinancing Risk: CEREIT is due to refinance EUR 450 million of medium-term notes in November 2025. With current interest rates significantly higher than when the notes were issued (2.1% vs. an expected 4.7%), refinancing will increase financing costs, potentially impacting future distributions.
2. Slower-than-expected Growth in Europe: Economic uncertainties and slower-than-expected rate cuts in Europe could affect leasing demand and property valuations, particularly in the office segment.
3. Higher Redevelopment Costs: CEREIT has a redevelopment pipeline of over EUR 200 million. Any cost overruns could delay projects and necessitate additional borrowing, increasing financial pressure.

Conclusion:

Cromwell European REIT offers a compelling investment opportunity, with high-quality, green-certified assets and a well-diversified tenant base that reduces risk. While the REIT faces challenges from rising financing costs and office asset divestments, its strategic pivot towards logistics and industrial assets positions it well for long-term growth. With an attractive valuation and a target price of EUR 1.87, CEREIT offers 22% upside potential, making it a solid buy for investors seeking exposure to the European real estate market.

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