Notes on Cromwell Reit

The European Industrial Property Market

Where are we in the property cycle?

We are late in the cycle.  The European Industrial and Logistics market has been recovering since 2013, and yields have been driven down by investment:

                Source: Cromwell 4Q18 Results Presentation, 27 Feb 2019

This doesn't mean we are at the top.  That will probably only happen now if there's a slowdown or recession.  This is the same risk for buying any stock.  Personally, I'm dealing with that risk by remaining half in cash.

The Properties

A miscellaneous collection of light-industrial and office properties across Europe, with no underlying theme.

              Source: Cromwell Rights Issue Presentation, Oct 18.

Most properties are freehold, less than 10% leasehold:

               Source: Cromwell Rights Issue Presentation, Oct 18.

Most of their buildings are generic industrial, warehouse or office buildings:

Only 2 buildings, or less than 1% of their portfolio, are customised for the tenant.  Both are leased to the Italian Police.

The largest tenant is the Italian State Property Office (Agenzia Del Demanio), who manage real estate assets for the Italian Government, at 16% of revenue:

Since their property is freehold, it has redevelopment potential.  They mention Parc des Dock St Ouen in Paris (p16), with an estimated Euro 1bn (0.45 per share) redevelopment potential over 10-15 years.

Tenant Quality

Hard to tell, most buildings are multi-let.

I'm worried about their largest tenant - the Italian State Property Office - cutting their budget, as Italy's budget deficit is too high for its slow growth.

Management Quality

Hard to say, as they've only been listed for a year.  During that time they made a rights offering to acquire more properties.  This was accretive for those who subscriber, but dilutive for those that did not.

Kyith Ng from Investment Moats makes the point that the managers are the same people from the parent, and they previously did a bad job of timing their purchases, especially with Valad Property Group.

So neutral to slightly negative on Management Quality.  The stock might be re-rated if they can prove themselves over a few years.

[Edit May 2019: Cromwell Property Group owns 35% of the REIT, which aligns their interest somewhat.]

The Numbers

Borrowing

Gearing ratio is around 33.9% to 37% (p41).   No perpetual bonds.  Their preferred range is 35-38% (p205).

Debt expires in 2020/2021.  A bit lumpy for my liking, but they said they want to refinance to 2020 debt now:

Most debt is floating rate, or only hedged short term:

• 18% of it is floating rate
• 40% is hedged for 1 year or less
• 15% for 2-3 years
• 14% for 4 years or more.
• 13% is fixed rate

Unencumbered Buildings: Around 20%, or 19 out of 92 buildings are unencumbered:

• 14 out of 60 light industrial buildings (in either France, Germany or the Netherlands) are unencumbered.  We do not know which.  
• Out of the 32 "Office & Other" buildings:
• The Ivrea, Barea and Genova properties in Italy are unencumbered (p207).  These have a valuation of 121m.
• 2 other of these buildings are encumbered, we do not know which.

Leases

WALE is 4.7 years, quite long for industrial property.
Lease expiry is around 10% per year until 2022:

I am guessing that they will not have more than 20% lease expiry an any single year from 2022 onwards.

Quality of Distributable Income

Income Support: No sign of income support in the Income or Cashflow statements.

Management fee is 4.9% of Distributable Income (p7).  Trust expenses are 6.1% - these seem to be recurring (eg: annual listing fees, legal/valuation/audit/accounting fees).  I have not looked at enough REITS to tell if these fees are high or low.

100% of management fees are paid as newly issued units.

Valuation

The trailing yield at a share price of Euro 0.51 is 7.5%.  This should increase next year as the newly acquired properties contribute.  Maybe 8%.

100% of distributable income is payed out as dividends (I would prefer 90%).
[Edit June 2019: This is only until "end of the 2019 financial year. Thereafter, CEREIT will distribute at least 90% of its annual distributable income for each financial year." p10 ]

Summary

Risks are:

• European slowdown or recession.  
• Property market cycle: oversupply caused by low or negative interest rates
• EU breakup.  Their properties and loans may end up being in different currencies.
• Rising rates would cause problems, unless they hedge more.
• They will have to issue more units if they want to expand.  Like they did previously.
• Budget cuts from their largest tenant - the Italian Government

I think this is REIT is OK at the current price, the risks are priced in.  And I think the yield is sustainable.

I bought 10,000 shares at Euro 0.495.