Investors cool on real estate groups as the tide of cheap money recedes

In March of last year, Swedish real estate tycoon Roger Akelius identified future challenges for the company he founded three decades ago and decided to take some chips off the table.

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

Six months later, the company entered into a deal to sell nearly 30,000 apartments in Germany, Denmark and Sweden to competition from Swedish real estate firm Heimstaden Bostad, which took on the equivalent of more than $ 6 billion in new debt to complete a deal. worth over $ 10 billion. .

“Heimstaden doubled the size of its portfolio and leveraged it to do so,” said David Shnaps, senior analyst at research firm CreditSights. “At the time, I was thinking, one of these guys is right and the other is not.”

A year later, with rising interest rates and spiraling inflation threatening debt-laden owners, Akelius appears to have been avenged.

At the same time, bond investors, who have been lending more and more money to European real estate companies at ever lower yields in recent years, worry about these companies. Losses on real estate bonds outperformed 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 purchase program in July, issuing new bonds has ceased.

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

Now that the tide of cheap money has run out, some heavily indebted European real estate companies are at risk of running aground.

Rebased index line chart, percentage change this year showing real estate bond yields have fallen more than other companies

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

The lack of housing supply and population growth on the continent have encouraged businesses to grow by borrowing. Demand for residential real estate only increased during the coronavirus pandemic, and with cheap debt readily available, real estate investors were willing to buy new properties with historically low rental yields.

In addition to rising financing costs, owners now also have higher fuel, material and labor costs. Then there is the important question of how tenants will cope with rising rents given the current income squeeze.

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

Troubled waters

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

In the background was Cevdet Caner, an Austrian real estate tycoon who had presided over Germany’s second real estate bankruptcy at the age of 35. On paper he played a passive role in Adler, having built a stake in the company through his family’s investment foundation, but in the tight-knit European real estate sector, it was a secret from Pulcinella 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 very critical report on Adler and his connections with Caner in 2021.

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

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

In response to the KPMG review, Adler’s chairman said “fraud and deception” had not been discovered. Caner said the report had “refuted the viceroy’s damaging allegations from a financial and reputational point of view.”

But the episode proved painful for Adler’s bondholders. Some bonds in its debt stack of over € 7 billion are trading at just over 50 cents on the euro.

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

“Adler’s situation is having a contagious effect, because investors are now re-evaluating what they thought was a safe annuity risk, as it is now much more risky,” said Gabriele Foà, portfolio manager at Algebris.

For some, Adler’s problems are indicative of wider governance problems in the club world of European real estate.

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 of this year, the viceroy lit fire on Swedish real estate firm Samhallsbyggnadsbolaget i Norden, claiming that the “debt-fueled” residential firm had overestimated the value of its assets and conflicts of interest on its board of directors. SBB denied the viceroy’s allegations in press releases.

Some of the viceroy’s criticisms centered on the company’s “staggering” pile of debt. The short seller calculated SBB’s loan-to-value ratio, the sector’s measure of debt to equity, to be nearly 70 percent if the hybrid bonds it issued were debt rather than equity.

While this was far higher than the 46 percent SBB reported in the first half of 2022, the company said that classifying hybrid loans as equities “is not uncommon” in the real estate sector. Its bonds have not lost as much value as those issued by Adler.

Steps to cancel the debt

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

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

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

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Bankers expect other companies to dump properties to reduce debt to more manageable levels, but while some are pulling out of the market, others are willing to buy.

Heimstaden, Europe’s second largest residential real estate company, spent an additional 217 million euros to purchase more than 2,000 homes from Finnish company Sato in April.

Christian Fladeland, Heimstaden’s chief investment officer, said the housing shortage across Europe means that “the fundamentals for residential investment” remain strong.

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But investors are less confident. While Akelius Residential’s loan-to-value ratio, the industry’s measure of debt to assets, is now at 9%, Heimstaden’s was over 45% in Q2 results.

“We are not that positive [on real estate] in an environment of rising interest rates, “said Philippe Dehoux, head of global bonds at asset manager Candriam.” The sector has a lot of debt. ”

Foà di Algebris added that he was wary of the real estate sector. “The real estate sector has leveraged a lot. They are very, very cyclical ”.

Companies are still not overly concerned about debt repayment, however, as few bonds will mature before the end of 2023 and 2024. “What you need to worry about more is a catalyst,” said one banker. “If the rating agencies preemptively move to someone, if someone is having difficulty paying rent or is held back by government regulation.”

But as conditions worsen, groups with less access to money may struggle to refinance debt. “Perhaps that leads to consolidation within the industry, with smaller names getting into trouble and being bought over the course of the next year or two,” said another banker.

Another long-term investor is also not done looking for opportunities in the European real estate sector. According to Roger Akelius: “At the end of the crisis, in the next three or four years there will be many opportunities to acquire properties in good locations.”

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