A new wave of real estate pain is coming after $148bn rout

Roiled by rising borrowing costs and falling valuations that wiped out $148bn of shareholder value, European landlords are bracing for a new wave of pain.

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

The headwinds include a crash in office values from the City of London to Berlin, leaving property as the least popular industry among fund managers for the third straight month, according to a Bank of America Corp. survey. Bloated with debt, many landlords will have to turn to asset sales, dividend cuts and rights issues in an attempt to rightsize the firms for a more turbulent future.

“The maturity wall could be a catalyst for transactions to happen because if borrowers are not able to refinance, they will have to exit,” said Jackie Bowie, head of EMEA at Chatham Financial. “You’ll have more assets sold in the market, I suspect, at distressed levels.”

Debt millstone for real estate

The poster child for the rout has been Swedish property firm Samhallsbyggnadsbolaget i Norden AB, which has plunged more than 90 per cent since its all-time high.

Its debt pile of $8bn, used to build up a portfolio of more than 2,000 properties, has turned into a millstone following the end of the cheap money era. The company’s efforts to shrink have attracted interest from the likes of Brookfield Asset Management, causing the share price to rally on Friday.

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

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

‘Strong Incentive’

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

Maintaining the rating, however, may prove unaffordable for some, not least because landlords’ hybrid bonds have tanked on the secondary market.

Some bondholders are losing patience, selling notes back to the real estate firms that issued them, including Aroundtown SA and Sweden’s Heimstaden Bostad AB. The attraction of the liability management for landlords is obvious: prices for high-grade euro-denominated notes have fallen by almost a fifth since the start of 2022.

“Large, and sudden moves in nominal rates create uncertainty and it’s important to maintain financial discipline to navigate such periods,” said Heimstaden AB, chief investment officer Christian Fladeland. “We consider this to be reflected in our strong balance sheet, hedging policy, and the balanced maturity profile of our debt.” Aroundtown and SBB did not reply to requests for comment.

Other firms will turn to rights issues or expensive alternative forms of debt to reduce their burden, eating into earnings over time.

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

The peak-to-trough selloff since August 2021 is nearing 50 per cent, or $148bn, leaving the Stoxx 600 Real Estate Index at a record low relative to the benchmark European stocks index.

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

It’s also left real estate markets almost frozen with buyers demanding higher yields to compensate for the risk of rising interest rates and tenants leaving. The price of prime office buildings in Paris, Berlin and Amsterdam dropped more than 30 per cent in 12 months, according to broker Savills.

“Sentiment is still pretty bad and that’s what’s reflected in this market pricing,” said Bowie at Chatham Financial.

Further Falls

There may be worse to come. Commercial real estate values in Europe could fall by as much as 40% because of the extent to which debt markets have been upended, Citigroup Inc. analyst Aaron Guy wrote in a note earlier this month.

In addition, he wrote, landlords may have to provide about 50% additional equity when they refinance an asset in order to satisfy metrics that banks and private credit funds lend against. That’s based on a refinancing rate of 6%.

The uncertainty has left money managers wary.

“We are staying out of the sector,” said Lucas Maruri, a fund manager at MAPFRE Asset Management, which manages about €40 billion. “We estimate that there are still risks that prevent the good performance of the shares of real estate companies, REITs and European developers over the coming months.”