Real Estate Credit Investments Ltd (LON:RECI) is the topic of conversation when Hardman & Co’s Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.
Q1: Your recent report on Real Estate Credit Investments sits behind a disclaimer. What can you tell us about that?
A1: It is just the standard disclaimer that many investment companies have. In essence, for regulatory reasons, there are some countries (like the US) where the report should not be read. It is not a simple asset class, and the report should only be looked at by professional/qualified investors.
Q2: Mark, we’re talking about your latest report on RECI called ‘French and German exposures in perspective’, what can you tell us about it?
A2: We last reviewed their operations in France, 25% of the latest portfolio, in our note, ‘Vive la difference’, published 15 February 2022. The core approach is unchanged, but, following the December report of an unrealised hit of 1.6p to the NAV from a prime Grade A Paris office exposure, we thought we would review them again. Also, in November, there was a 1.1p NAV hit from a legacy mezzanine position exposed to a Berlin asset, so we have considered the de minimis German exposure.
Our conclusions were that, while the losses were unexpected, they are unrealised, and the conservatism in RECI’s accounting is an important issue.
Q3: So, you say the accounting is conservative, what does that mean in practice when looking at the French exposure?
A3: Changes in working patterns post COVID-19 have seen a slow take-up of non-central Paris office space, which meant the development project was unlikely to achieve the previously expected rent roll. In looking at how they then came to take a hit on a project with an initial 58% loan to value, it is worth considering potential upsides and downsides.
Taking the upsides, first, there is their conservative approach to accounting, which, historically, has seen it take mark downs only for there to be releases in future periods; secondly, the valuation is based off discounted cashflows, so there is a positive unwind of discount; and thirdly, there is the potential for improving capitalisation rates if interest rates were to fall.
In a very dynamic market, there are some uncertain issues, which include rent roll, and the potential early sale of the asset, but the bias of outcomes, and supported by historical results, is that they have been conservative.
Q4: And read across to other French exposures, what has happened there?
A4: There are eight French exposures in total, accounting for 25% of the NAV. Within the Real Estate Credit Investments’ top 10 exposures, as at end-January 2024, there were three based in France and they account for the majority of the exposure, at 19% of RECI’s total NAV.
Looking at the impaired project compared with the rest, the former has proved unusual in that sponsors proved unwilling to put more equity into the deal when required. While it was a prime development, it was in outer Paris while most of the other exposures are in more prime locations. Across the whole portfolio, there is sector and counterparty diversity split across hotels, office, logistics and co-living.
The three largest exposures are all well established, with the smaller two being originated in 2021 and the largest in 2019. This means that Cheyne is very familiar with the projects, how they have progressed and the quality of their counterparties. As a general rule, newer lending is higher risk than established exposures.
Q5: And Germany?
A5: German exposure is now 1% of NAV. All the same issues we identified in France; the conservatism in accounting, discount-based valuations, benefit of improved cap rates with falling interest rates, an unrealised loss, also apply here.
The German market is weaker than the French one and this exposure is a legacy, mezzanine finance deal, both of which could see greater volatility, up or down, but, at 1% of NAV, the German exposure is very modest.
Q6: And the risks?
A6: The risks of a recession are clear to see, with higher interest rates, lower disposable income, falling property prices, both residential and commercial, compounded by distressed sellers of assets, rising social tensions, governments facing large fiscal deficits and central banks’ inflationary pressures.
