Investors cool on property groups as tide of cheap money recedes

In March last year, Swedish property magnate Roger Akelius spotted the challenges ahead for the company he founded three decades ago and decided to take a few chips off the table.

Akelius Residential Property had been riding a wave of rising house prices and falling interest rates. Now the 77-year-old property mogul has presented his board with a simple plan to ‘safeguard current profits’: sell assets and pay down debt. “We will sell Stockholm, Malmö, Copenhagen, Hamburg, Berlin,” he wrote in an email to board members.

Six months later, the company struck a deal to sell nearly 30,000 apartments in Germany, Denmark and Sweden to compete with Swedish property company Heimstaden Bostad, which took on more than $6 billion worth of new debts to close a deal worth more than $10 billion. .

“Heimstaden has doubled the size of its portfolio and built on doing so,” said David Shnaps, principal analyst at research firm CreditSights. “At the time, I thought, one of these guys is right and the other isn’t.”

A year later, with rising interest rates and soaring inflation threatening debt-ridden homeowners, Akelius appears to have been vindicated.

At the same time, bond investors, who in recent years have lent more and more money to European property companies at ever lower yields, are worried about these companies. Losses on real estate bonds have outpaced the broader corporate debt market this year.

Roger Akelius, founder of Akelius Residential Property © Mats Nolebring

A high-profile governance scandal at German residential real estate group Adler has cast a shadow over the sector, and since the European Central Bank ended its bond-buying program in July, new debt issuance has are stopped.

Interest rates this low are not normal,” Akelius told the Financial Times. “You can almost play with the central banks but you can’t play with the whole market for several years. The nature of the economy will take its revenge.

Now that the tide of cheap money has died down, some highly indebted European property companies are at risk of running aground.

Line chart of rebased indices, percentage change this year showing that property bond yields have fallen more than those of other companies

After accounting for less than 1% of outstanding European corporate bonds in 2012, real estate debt accounted for almost 6% of the market last year, according to analysis by Legal and General Investment Managers.

Insufficient housing supply and population growth on the continent have encouraged businesses to expand by borrowing. Demand for residential properties only increased during the coronavirus pandemic, and with cheap debt readily available, property investors were ready to buy new properties at historically low rental yields.

In addition to higher borrowing costs, owners now have higher fuel, material and labor costs. Then there is the all-important question of how tenants will cope with rent increases, given the current pressure on incomes.

Accommodation in Sweden
Insufficient housing supply and population growth in Europe have encouraged businesses to expand by borrowing © Heimstaden

rough waters

Adler embodies the excesses of the years of easy credit. Through a series of debt-fueled acquisitions, the little-known company grew into a sprawling conglomerate that owned 70,000 apartments across Germany.

In the background was Cevdet Caner, an Austrian property magnate who presided over Germany’s second-largest property bankruptcy at the age of 35. On paper, he had a passive role in Adler, having acquired a stake in the company through his family’s investment foundation. , but in Europe’s close-knit property industry, it was an open secret that he was heavily involved in the group.

In 2020, a whistleblower told regulators and lenders that Caner was hiding his involvement in Adler through “complicated opaque structures.” Short seller Viceroy Research then released a highly critical report on Adler and his ties to Caner in 2021.

A subsequent forensic examination of Adler’s accounts by KPMG revealed extensive evidence that Caner not only had significant involvement in decision-making at Adler, but also received payments from the company.

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In April this year, the company refused to sign Adler’s accounts, then resigned as auditor. Adler has yet to find a replacement. Last month, German financial watchdog BaFin found that Adler had overstated its 2019 accounts by up to 233 million euros.

In response to KPMG’s review, Adler’s chairman said no “fraud and deception” had been uncovered. Caner said the report “refuted Viceroy’s reputational and financial damage claims.”

But the episode proved painful for Adler bondholders. Some bonds of its debt of more than 7 billion euros are trading at just over 50 cents on the euro.

It was also a more general wake-up call for investors.

“The Adler situation has some contagion effect, as investors are now reassessing what they thought was a safe annuity-type risk – as now much riskier,” said Gabriele Foà, portfolio manager at Algebris.

For some, Adler’s troubles are indicative of wider governance issues in the clubby world of European property.

An excavator works on the construction of new apartment buildings
An excavator works on the construction of new apartment buildings for Samhallsbyggnadsbolaget i Norden © Jeppe Gustafsson/Alamy

In February this year, Viceroy turned fire on Swedish property company Samhallsbyggnadsbolaget i Norden, alleging the ‘debt-fuelled’ residential company had overstated the value of its assets and conflicts of interest on its board of directors. ‘administration. SBB denied Viceroy’s allegations in press releases.

Some of Viceroy’s criticisms centered on the company’s “mind-boggling” indebtedness. The short seller calculated CFF’s loan-to-value ratio, the industry’s measure of debt to assets, at almost 70%, if the hybrid bonds it issued were in the form of debt rather than equity .

While that figure is well above the 46% reported by SBB in the first half of 2022, the company said classifying hybrid loans as equity is “not unusual” in real estate. Its bonds have not lost as much value as those issued by Adler.

Steps to Clear Debt

In Germany, Vonovia – the country’s largest property company and Adler’s largest shareholder – is taking steps to ease pressure on its balance sheet.

As debt markets have cooled, with new corporate bond issuance falling 16% in Europe in the first half of 2022, Vonovia chief executive Rolf Buch told analysts on a recent call. to the results that the company would sell 13 billion euros of assets “as quickly as possible” to provide cash.

“Neither new equity nor new debt are viable options in this market,” said Philip Grosse, chief financial officer of Vonovia.

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Bankers expect more companies to offload assets to reduce debt to more manageable levels, but while some are pulling out of the market, others are ready to buy.

Heimstaden, Europe’s second-largest residential property company, spent an additional €217 million to buy more than 2,000 homes from Finnish company Sato in April.

Heimstaden chief investment officer Christian Fladeland said housing shortages across Europe mean “the fundamentals for residential investment” remain strong.

But investors are less certain. While Akelius Residential’s loan-to-value ratio, the industry’s measure of debt to assets, now stands at 9%, Heimstaden’s was above 45% in its second-quarter results.

“We are not so positive [on real estate] in a rising rate environment,” said Philippe Dehoux, head of global bonds at asset manager Candriam. “The sector is very indebted.

Foà d’Algebris added that he was wary of the real estate sector. “Real estate has increased a lot. They are very, very cyclical.

However, companies are not yet too worried about debt repayment, as few bonds will mature before the end of 2023 and 2024. “What you will need for more worries to trigger is is a catalyst,” said one banker. “If the rating agencies are preemptively acting on someone, if someone is struggling to pay their rent, or if they’re being held back by government regulations.”

But as conditions worsen, groups with less access to cash could struggle to refinance debt. “Perhaps this is leading to consolidation within the industry, with smaller names having issues being bought up over the next two years,” another banker said.

Another long-term investor is also not done finding opportunities in European real estate. According to Roger Akelius: “Coming out of the crisis, there will be plenty of opportunities to acquire well-located properties in the next three or four years.”

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