(Bloomberg) — Agitated by rising borrowing costs and falling valuations that have eroded $148 billion in shareholder value, European landlords are bracing for a new wave of pain.
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Real estate companies have about $165 billion worth of bonds maturing in 2026, while banks are reducing exposure to the industry and borrowing costs are at their highest since the financial crisis. This puts some companies at risk of being downgraded to junk status, making it even more expensive for them to borrow.
Headwinds include a crash in office prices from the City of London to Berlin, pushing property down, according to a Bank of America Corp. survey. the least popular industry among fund managers for the third month in a row. Bloated with debt, many landowners are having to resort to asset sales, dividend cuts and rights issues to prepare their businesses for a more turbulent future.
“Maturity cap could be a catalyst for transactions because if borrowers are unable to refinance, they will have to exit,” said Jackie Bowie, head of EMEA at Chatham Financial. “I suspect more assets are being sold at distressed levels in the market.”
The poster child for the bankruptcy was Swedish property company Samhallsbyggnadsbolaget i Norden AB, which has fallen more than 90% from its all-time high.
His $8 billion debt, which has been used to build a portfolio of more than 2,000 properties, has turned into a millstone after the end of the easy money era. The company's downsizing efforts have drawn interest from companies like Brookfield Asset Management, leading to a rise in the share price on Friday.
The landlord has already been downgraded to scrap, prompting it to abandon a proposed rights issue, and the market is pricing in the prospect of others to follow. According to a quantitative model conducted by Bloomberg, most of the real estate bonds in the Euro Prime Bond Index have been issued by companies whose credit ratings are now closer to those of junk status.
If they fail to reduce their debt piles or if lending rates come down again, these so-called fallen angel candidates will likely have to pay higher interest rates on their loans when they eventually restructure.
“There will be a very strong incentive for many of these issuers to return to investment grade. We have already seen them trying to defend this line in the sand as their business model is not inherently high yield,” said Viktor Hjort, global head of credit strategy and desk analyst at BNP Paribas SA.
Maintaining the rating, however, could prove prohibitive for some, not least because rental hybrid bonds have plummeted in the secondary market.
Some money managers are losing patience and selling back the bonds to the real estate companies that issued them, including Aroundtown SA and Sweden's Heimstaden Bostad AB. The attraction of liability management for landlords is obvious: the prices for high-quality euro bonds have fallen by almost a fifth since the beginning of 2022.
“Large and sudden swings in nominal interest rates create uncertainty and it is important to maintain financial discipline to navigate such periods,” said Christian Fladeland, Chief Investment Officer of Heimstaden AB. “We believe this is reflected in our strong balance sheet, hedging policy and balanced maturity profile of our debt.” Aroundtown and SBB did not respond to requests for comment.
Other companies will resort to rights issuance or expensive alternative forms of debt to ease their exposure, resulting in lost profits over time.
As a result, there have been no red flags seen on the stock markets since the financial crisis. Forward price-to-book multiples suggest these stocks are trading at their lowest levels since 2008. The metric measures the value of a company's shares compared to the value of its assets.
The sell-off from peak to trough since August 2021 is approaching 50 percent or $148 billion, leaving the Stoxx 600 Real Estate Index at a record low relative to the European benchmark stock index.
The greater turmoil cost British Land Plc its place on the FTSE 100 after more than two decades, while the owner of London's financial district of Canary Wharf was left even more bankrupt. A spokesman for British Land declined to comment. Canary Wharf Group did not respond to a call for comment.
British Land loses FTSE 100 spot after two decades in the Index (1)
Also, real estate markets are virtually frozen as buyers are demanding higher yields to offset the risk of rising interest rates and tenant exodus. According to broker Savills Plc, prime office building prices in Paris, Berlin and Amsterdam have fallen by more than 30% in 12 months.
“Sentiment is still pretty bad and that's reflected in this market pricing,” Chatham Financial's Bowie said.
This is part of a global trend that has seen the volume of distressed real estate bonds and loans traded exceed $190 billion. That's in contrast to other industries, where it's shrunk in recent months.
Worse could come. Commercial real estate values in Europe could fall by as much as 40% due to the extent to which debt markets have been turned upside down, Aaron Guy, an analyst at Citigroup Inc., wrote in a note earlier this month.
Additionally, he wrote, when refinancing an asset, landlords might need to provide about 50% additional equity to meet the metrics by which banks and private debt funds lend. A refinancing rate of 6% is used as a basis.
We “anticipate valuations still need to be adjusted lower.” “That means there's 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 has made wealth managers suspicious.
“We're staying out of this sector,” said Lucas Maruri, fund manager at MAPFRE Asset Management, which has around €40 billion under management. “We believe that there are still risks that prevent real estate companies, REITs and European developers from performing well in the coming months.”
– With the support of Macarena Muñoz.
(Updates on the extent of the housing crisis in the paragraph above the subheading “More Falls”)
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