A new wave of real estate pain arrives after the European rout

(Bloomberg) – Reeling from rising borrowing costs and falling valuations that have wiped out $148 billion in shareholder value, European homeowners are bracing for another wave of pain.

Bloomberg’s Most Read

Property companies have about $165 billion in bonds maturing through 2026, while banks are reducing exposure to the sector and credit costs are at their highest since the financial crisis. This has left some of the companies at risk of being downgraded to junk status, making it even more expensive for them to borrow.

Headwinds include a slump in office values ​​from the City of London to Berlin, leaving real estate as the least popular industry among fund managers for the third straight month, according to a Bank of America Corp survey. Bloated by debt, many owners will have to turn to asset sales, dividend cuts and rights issues in a bid to right-size businesses for a more turbulent future.

“The maturity wall could be a catalyst for deals to happen because if borrowers are unable to refinance they will have to exit,” said Jackie Bowie, EMEA head at Chatham Financial. “You will have more assets sold in the market, I guess, at distressed levels.”

Debt millstone

The star child of the rout was Swedish property company Samhallsbyggnadsbolaget i Norden AB, which has plunged more than 90% from its all-time high.

His $8 billion in debt, used to build a portfolio of more than 2,000 properties, turned into a cornerstone after the era of cheap money ended. The company’s efforts to shrink attracted interest from companies like Brookfield Asset Management, sending the stock price rallying on Friday.

The owner has already been downgraded to junk, leading him to abandon a planned rights issue, and the market is pricing in the prospect that others will follow. The majority of real estate bonds in the blue-chip euro bond index were issued by companies that now have a credit quality more typical of those with junk status, according to a quantitative model run by Bloomberg.

Unless they can reduce their debt or borrowing rates fall again, these so-called fallen angel candidates will likely have to pay higher rates for their credit when they eventually refinance.

‘Strong incentive’

“There will be a very strong incentive for many of these issuers to return to investment grade. We’ve seen them try to defend that line in the sand before because their business model is not naturally a high-return model,” said Viktor Hjort, global head of credit strategy and desk analysts at BNP Paribas SA.

Maintaining the rating, however, may prove unaffordable for some, particularly as owners’ hybrid bonds have fallen in the secondary market.

Some fund managers are losing patience and reselling the notes to the property companies that issued them, including Aroundtown SA and Heimstaden Bostad AB in Sweden. The appeal of liability management for owners is clear: prices for high-quality euro-denominated notes have fallen by almost a fifth since the start of 2022.

“Big and sudden movements in nominal rates create uncertainty and it is important to maintain financial discipline to weather such periods,” said Christian Fladeland, Chief Investment Officer of Heimstaden AB. “We consider this to be reflected in our strong balance sheet, our hedging policy and the balanced maturity profile of our debt.” Aroundtown and SBB did not respond to requests for comment.

Other companies will turn to rights issues or expensive alternative forms of debt to reduce their burden, which will eat away at profits over time.

This has left corners of the equity market flashing red flags not seen since the financial crisis. Forward price-to-book multiples suggest these stocks are trading at the cheapest levels since 2008. The metric measures the value of a company’s stock relative to the value of its assets.

The peak-to-trough selloff since August 2021 is nearing 50%, or $148 billion, leaving the Stoxx 600 Real Estate Index at an all-time high relative to the benchmark European stock index.

The wider turmoil has cost British Land Plc its place in the FTSE 100 after more than two decades, while the owner of London’s Canary Wharf financial district has been downgraded deeper into junk. A British Land spokesperson declined to comment. Canary Wharf Group did not respond to a call for comment.

British Land loses its place in the FTSE 100 after two decades in the index (1)

It has also left property markets nearly frozen, with buyers demanding higher yields to offset the risk of rising interest rates and tenants leaving. The price of prime office buildings in Paris, Berlin and Amsterdam has fallen by more than 30% in 12 months, according to broker Savills Plc.

“The sentiment is still pretty bad and that’s reflected in the prices in this market,” said Bowie of Chatham Financial.

It’s part of a global trend that has seen the amount of real estate bonds and loans traded at distressed prices top $190 billion. This contrasts with other industries, where it has been declining in recent months.

other falls

There may be worse to come. Commercial real estate values ​​in Europe could fall by up to 40% due to the extent to which debt markets have been shaken up, Citigroup Inc. analyst Aaron Guy wrote in a note earlier this month. -this.

In addition, he wrote, owners may be required to provide around 50% additional equity when refinancing an asset in order to satisfy measures against which banks and private credit funds lend. This is based on a refinancing rate of 6%.

We “assume that valuations still need to adjust downwards. This means there is even more pain to come,” said Max Berger, credit portfolio manager at DWS Investment GmbH. “Some of these business models are no longer viable. The bond markets are well aware of this.

The uncertainty made fund managers wary.

“We stay out of the sector,” said Lucas Maruri, fund manager at MAPFRE Asset Management, which manages around 40 billion euros. “We believe that there are still risks that prevent the good performance of shares of real estate companies, REITs and European developers in the coming months.”

–With the help of Macarena Muñoz.

(Updates with extent of real estate distress in paragraph above Other Falls subheading)

Bloomberg Businessweek’s Most Read

©2023 Bloomberg LP

Leave a Comment