Banks make money by lending against property - a principle with which those who have taken out a mortgage will be wearily familiar. The notion that investors can sit on the other side of the trade is less familiar. Yet that's precisely the opportunity offered by shares in Starwood European Real Estate Finance (SWEF), a newly launched investment trust.
- Expected dividend yield exceeding 6 per cent
- Low-risk, asset-backed investment
- Asset manager has strong US track record
- Vast funding gap for European mortgages
- New company with an unfamiliar plan
- Vulnerable to rising interest rates
The first of its kind in London, Starwood will use the £229m it raised in December to issue mortgages against commercial property in the UK and continental Europe. Roughly half of its assets will be so-called 'whole loans' - it will be the sole lender against a property. The other half will be riskier, yet higher-yielding, mezzanine loans, where another lender has a prior claim on the collateral. Overall, Starwood expects the portfolio to yield 8-9 per cent when it is fully invested at the end of this year. After costs, that should allow the trust to distribute 7 per cent of its capital each year in dividends. With its shares trading a little above book value, that should mean a 6.6 per cent yield on 2014's payout (see table).
Maybe it's odd that a mortgage fund, such as Starwood European, has not been done before. The answer is that until recently banks accounted for some 95 per cent of European property debt, according to investment bank Morgan Stanley. But as banks have come under pressure to hold more capital they have retreated - opening a gap for 'shadow' lenders such as Starwood.
But these new lenders have nothing like the scale of their ailing predecessors. Morgan Stanley estimates that banks will reduce their property exposure by €350bn-€600bn (£230bn-£400bn) over the next half decade, on top of which €85bn of mortgage-backed securities are due to mature. The broker reckons that new lenders will provide €200bn, leaving a vast funding gap.
STARWOOD EUROPEAN REAL ESTATE FINANCE (SWEF) | ||||
|---|---|---|---|---|
| ORD PRICE: | 106p | MARKET VALUE: | £242m | |
| TOUCH: | 105-106p | 12-MONTH HIGH: | 106p | LOW: 100p |
| DIVIDEND YIELD: | 6.6% | NET DEBT: | na | |
| PREMIUM TO NAV: | 8% | |||
| Year to 31 Dec | Net asset value (p) | Pre-tax profit (£m) | Earnings per share (p) | Dividend per share (p) |
|---|---|---|---|---|
| 2012 | 98 | na | na | na |
| 2013* | na | na | na | 3.5 |
| 2014* | na | na | na | 7.0 |
| % change | – | – | – | +100 |
Normal market size: 4,000 Matched bargain trading *Dividend forecasts detailed in the prospectus | ||||
This gap explains why Starwood can realistically target high returns with limited risks. The fund's managers expect an average loan-to-value ratio of less than 75 per cent, meaning that property values would have to fall by more than a quarter for its book value to come under big pressure. With UK values already at least a quarter down on their 2007 peak, that's unlikely.
Judging by the one deal it has signed, the trust's return estimates look conservative. In December it lent £19m as part of a mezzanine package for the £547m refinancing of the Maybourne Hotel Group. The loan will earn a double-digit yield, management says, even though it is secured against three luxury London hotels - Claridge's, the Connaught and the Berkeley - at a loan-to-value ratio in the low 50s.
Potential investors in this European fund can also be reassured by the track record of the Starwood Property Trust, a $3.8bn (£2.5bn) US real-estate investment trust that was launched by the same asset manager, Starwood Capital, with a near-identical plan in August 2009. Its stock is up 42 per cent since launch and now trades at 35 per cent premium above book value, while still offering a dividend yield of 6.3 per cent (6.7 per cent if last year's special dividends are included).
