The Board of Cromwell have provided a comprehensive update on the Groups activities amid the COVID issues facing their Australian and European operations.
Whilst the Board continue to support their strategy, particularly with regard to their European portfolio, their desire to maintain a 40% gearing whilst rental incomes in Australia and Europe are declining, are warning signs to their security holders.
Recently appointed Independent Chair Leon Bltiz, said “the COVID-19 pandemic has created unprecedented uncertainty and dislocation within the global economy and commercial real estate markets. This has been reflected, to varying degrees, in the 14 countries in which Cromwell operates.”
Cromwell reported that they experienced the impact of the virus earlier than most with their Milan office moving to working from home in February. Since then, the Board has moved to minimize the impacts of the virus and now the recovery from it across its business.
Leon Bltiz, said “It is currently difficult to predict exactly how the recovery will unfold. Nevertheless with 44% of gross passing rent in Australia coming from government sources the Board is confident that Cromwell is well placed to manage through this period of uncertainty and benefit as market conditions improve,” he said.
Leon Bltiz also commented on the finding of the strategic review he initiated with UBS and Goldman Sachs following his recent appointment. “Cromwell’s absolute focus has been on managing through the COVID-19 crisis. The pandemic has presented its own unique set of challenges, but the review findings have been supported by the resilience of Cromwell’s rental and fee revenues over the last few months,” said Mr Blitz.
The findings by UBS and Goldman Sachs included:
• Cromwell’s business model was robust and resilient; and
• Cromwell’s strategy was appropriate to deliver returns for securityholders within the Board’s risk tolerance.
Whilst not revealing the report or its recommendations, Leon Blitz said that “When we have a better idea of the ‘new normal’ we will address some of the specific review recommendations”.
Cromwell also outlined the impacts from COVID on its income with rent-relief requests from 79 out of 95 SME tenant-customers who are covered by the Code, representing approximately 10% of gross passing income.
To date, some 22 requests have been finalised and 57 are in various stages of consideration. For the months of March, April and May 2020 combined only $8.2 million in rental income has not been paid, representing just 3.7% of total rent receivable in FY20. This does however imply that 15% of the rental charged over those 3 months has not been collected, which is a substantially higher number than the 10% of tenants covered by the Code. This suggests that the larger tenants are seeking similar treatment and which places the Group at a greater risk than currently suggested. Cromwell has however said that it "does not expect to offer abatements on material leases" (whatever that means).
In its European portfolio, Cromwell have been criticized, particularly by ARA, for acquiring third-party investment interests in the Cromwell Polish Retail Fund in late October 2019. The Fund consists of seven assets anchored by the French Grocery giant, Auchan, and the transaction was in the process of being restructured as an EU alternative investment fund (AIF), managed by Cromwell’s Luxembourg regulated manager, when the COVID-19 lockdown was announced in Poland. The subsequent sell-down, targeting an eventual longterm co-investment stake of 20% to 30% is on hold.
On 1st April 2020, the Polish Government introduced a law which temporarily suspended shopping centre lease agreements. The law was backdated to 14th March 2020 and ran until 4th May 2020 when phased re-opening commenced. Essential retail such as hypermarkets and pharmacies were considered outside the scope of the law and continued to trade throughout. To compensate landlords for the loss of income, within three months of the tenant-customer being permitted to reopen, they are obliged to submit an unconditional offer to extend the lease for the ‘closure period’ plus six months. Where a tenant fails to do so the temporary expiry of the obligations of the lease cease to apply, meaning they would be obliged to pay the rent for the period of the compulsory closure.
With regards to the Polish Retail Fund, rent collections for the closure period from 1st March 2020 are showing an overall collection rate of 57% with lease restructuring and extension discussions ongoing for tenant-customers who have not paid yet. To date, 337 of 350 tenant-customers are now permitted to trade following the lifting of Stage 3 restrictions on 18th May 2020 and from the 6th June 2020 all tenant-customers apart from nine travel agencies will be permitted to open.
Given the expected future performance of the Fund, quality of the underlying covenants and the speed and strength of the recovery expected in Poland, Cromwell has advised it is happy to hold the Fund on its balance sheet for the medium term until markets stabilise and the Fund can be relaunched. This will not be good news to the protagonists opposing the Fund takeover.
Elsewhere in Europe, Cromwell advised that its Eurpoean REIT (CEREIT) has €229 million cash in bank and 34.5% in net gearing, however the requests for rent to be reprofiled account for only approximately 18% of annual headline rent. The bulk of the requests involved temporarily transitioning from paying rent three months in advance to once a month as well as deferring rents or early lease renewals with up front rent-free incentives. The Manager has only agreed to abatements amounting to less than €260,000 and tenant-customers granted such abatements have either extended their leases or removed break clauses.
From a local liquidity perspective, Cromwell advises that it is expected to have approximately $670 million of cash and available undrawn facilities but feels that its 40% gearing is satisfactory. The Board advised that it "is comfortable with Cromwell’s current level of gearing and its ability to absorb any fluctuations in valuations".
At least 50% of the portfolio will be revalued at 30th June 2020 in accordance with Cromwell’s valuation policy.
Cromwell has confirmed it will pay a distribution for the June 2020 quarter of 1.875 cents per security, as originally forecast. The distribution payment will be covered by earnings and cash flow.
In terms of a further outlook, Cromwell believes that the impacts of COVID-19 will be manifold. In office markets companies may look to extend leases in the short term so as not to incur relocation costs while they repair balance sheets. In the medium term, the recent trend of densification which has seen occupancy ratios contract by 30% over the last decade is likely to unwind as businesses provide employees with more space. This may offset the number of employees who end up spending more time working from home.
Cromwell expects outperformance from those real estate managers with :
• Quality office assets with secure income streams;
• Owners and managers who can offer adaptive and flexible solutions to the changing requirements of occupiers ;
• Investment in logistics and warehousing as companies increase ‘on shore’ supply chains and move away from just in time delivery;
• Investment in higher quality and greater care for seniors;
• Investment in Data Centres due to ongoing increase in data consumption, spurred by remote working; and
• Exposure to grocery stores, hypermarkets and hardware ‘big box retailers’ as compared to discretionary and specialty retail.
Cromwell CEO Paul Weightman, “we are strongly positioned to take advantage of the opportunities that will emerge from market dislocation. We will assess these, and other opportunities, as they arise, and on their individual merit, in order to maximise returns for our securityholders and investors”.
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