On February 26, 2015, NorthStar Realty Finance Corp. (NYSE: NRF) announced plans to spin off its European real estate portfolio into NorthStar Realty Europe Corp. NorthStar Realty Europe will be its own separate publicly traded real estate investment trust, and will trade under the ticker symbol “NRE” on the New York Stock Exchange. The company may also be dually-listed in Europe. The spinoff is expected to be completed in the second half of 2015. For tax purposes, existing NRF shareholders will receive a distribution equal to the fair market value of the newly distributed NorthStar Realty Europe shares.
On July 1, 2015, NorthStar Realty Europe completed a private debt offering and raised $300 million through the issuance 4.625% senior stock-settleable notes, due December 2016. The senior, unsubordinated and unsecured notes issued by NorthStar Realty Europe are guaranteed by NorthStar Realty and NorthStar Realty Finance Limited Partnership. NorthStar Realty Europe has the option to settle part or all of the principal value of notes via stock instead of cash. Proceeds from the offering will be used for additional acquisitions of European commercial real estate and repayment of NorthStar Realty Finance’s indebtedness.
The company’s spin off assets – its European real estate portfolio – comprise of 50 commercial real estate properties valued at about $2 billion, and additional healthcare assets. The properties are located in Belgium, France, Germany, Italy, the Netherlands, Portugal, Spain, Sweden and the United Kingdom. The portfolio is largely focused on office properties (accounting for 90%), with some retail, hotel and logistics properties. Approximately 92% of the portfolio is currently occupied by strong credit tenants such as Ernst & Young and Cushman & Wakefield. The tenants have a weighted average lease term of about 5 more years under current contracts. NorthStar Realty obtained a majority of its European properties in the second quarter of 2015, primarily through its acquisitions of SEB (for $1.3 billion), Provinzial Nordwest ($550 million) and Madison International Realty LLC ($600 million).
The company acquired its European assets with a strong dollar which was virtually at 1-to-1 parity with the Euro which was down sharply, relative to the dollar, over the past year. Weakness in European economies also allowed acquisitions at favorable, undervalued prices which in itself offers property appreciation upside over the years.
Spreads between office property yields and 10-year government bonds in most European regions have been historically wide. In large cities like London, while the long-term 10-year average spread is at around 1%, the current spread is twice that at about 2%. In Frankfurt, the long-term 10-year average yield stands at about 2% while the current spread is again double that at about 4%. Economic conditions in Europe are expected to drive down yield spreads in the future.
And similar to the Federal Reserve’s stimulus bond purchase program (now discontinued after the U.S. economy showed clear signs of recovery), the European Central Bank (ECB) initiated a $67.8 billion monthly bond-buying program in March 2015 that is expected to last until at least September 2016 as part of the ECB’s effort to strengthen the Euro and revive the region’s battered economy that has come under additional pressure on signs of a slowdown in China. So, while currently beaten down, as countries in Europe recover, real estate properties are expected to further appreciate in value over time, and this should boost NorthStar Realty Europe’s portfolio. This upside is also reflected in the large premium to net asset value in Europe.
NorthStar Realty Europe has several comparative advantages over its European competitors. For example, through its American roots, the company will have better access to capital though debt and equity markets in the United States at advantageous cost of capital rates. With more capital at lower cost, the company can implement a regionally diversified investment strategy with no restrictions on asset class or jurisdiction, something most European companies cannot easily replicate. For shareholders, NorthStar Realty Europe offers real estate exposure to the ‘Pan-European’ region through a company based in the United States – under experienced management, with a proven track record, that does not trade at a significant premium.
NorthStar Realty Europe will be managed by NorthStar Asset Management Group (NSAM), which will also continue to manage NorthStar Realty, under a 20-year management agreement. The company will pay NSAM a base management fee of $10 million annually for its current portfolio plus 1.5% on any additional equity raised by NorthStar Realty Europe or by parent NorthStar Realty for transfer to NorthStar Realty Europe after completion of the spinoff. NorthStar Realty Europe will also pay incentive fees, to be established before the completion of the spinoff, based on cash available for distribution (CAD) per share. NSAM is experienced in large and complicated real estate transactions which will give NorthStar Realty Europe a leg up on its competition. Management will focus on keeping debt at manageable levels with a low-leverage strategy with a target of 40% to 50% loan-to-value on directly owned real estate assets. The NorthStar Realty Europe will have a Board comprised mostly of independent directors.
In a nutshell, NorthStar Realty Europe is will positioned to capitalize on current economic conditions and future growth, currency appreciation and real estate property price increases in the ‘Pan-European’ region – with the ECB actively focused on capital liquidity through its stimulus bond buying program, on keeping interest rates near all-time lows and doing all it can to drive economic recovery in the region. Further, Northstar management anticipates annualized cash-available-for-distribution (CAD) of $0.20 per share at 50% leverage on loan-to-value for properties – delivering solid dividend upside to income-oriented investors.