Investors cool on property groups as tide of cheap money recedes

In March last year, Swedish real estate mogul Roger Akelius spotted challenges ahead for the business he founded three decades ago and decided to take some chips off the table.

Akelius Residential Property had ridden a wave of rising property prices and falling interest rates. Now, the 77-year-old property tycoon presented a simple plan for “safeguarding present profit” to its board: sell assets and repay debt. “We will sell Stockholm, Malmo, 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 across Germany, Denmark and Sweden to rival Swedish property firm Heimstaden Bostad, which took on the equivalent of more than $6bn in new debt to complete a deal worth more than $10bn.

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

One year on, with rising interest rates and spiralling inflation threatening debt-laden landlords, Akelius appears to have been vindicated.

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

A high-profile governance scandal at German residential property group Adler has cast a shadow over the sector, and since the European Central Bank ended its bond-buying programme in July, new debt issuance has ground to a halt.

“Such low interest rates are not normal,” Akelius told the Financial Times. “You can almost play with the central banks but you cannot 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 gone out, some heavily indebted European property companies risk running aground.

Having accounted for less than 1 per cent of European corporate bonds outstanding in 2012, real estate debt made up nearly 6 per cent of the market by last year, according to analysis from Legal and General Investment Managers.

An undersupply of homes and population growth on the continent encouraged companies to grow by borrowing. Demand for residential property only increased during the coronavirus pandemic, and with cheap debt readily available, real estate investors were willing to buy new properties at historically low rental yields.

As well as rising borrowing costs, landlords also now have higher fuel, material and labour costs. Then there is the all important question of how tenants will cope with rent rises, given the current squeeze on incomes.

Choppy waters

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

In the background was Cevdet Caner, an Austrian property magnate who had presided over Germany’s second-largest real estate bankruptcy at the age of 35. On paper he had a passive role in Adler, having built a stake in the company through his family’s investment foundation, but in Europe’s close-knit real estate 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 concealing his involvement in Adler through “complicated opaque structures”. Short seller Viceroy Research then published a highly critical report on Adler and its links to Caner in 2021.

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

In April this year, the firm refused to sign off on Adler’s accounts and then resigned as its 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 €233mn.

In response to the KPMG review, Adler’s chair said no “fraud and deception” had been uncovered. Caner said that the report had “rebutted the financially and reputationally damaging allegations by Viceroy”.

But the episode has proved painful for Adler’s bondholders. Some bonds in its more than €7bn debt pile are trading at little over 50 cents on the euro.

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

“Adler’s situation is having some contagion effect, because investors are now reassessing what they thought was safe annuity-type risk — as now a lot riskier,” said Gabriele Foà, a portfolio manager at Algebris.

For some, the problems at Adler are indicative of wider governance issues across the clubby world of European real estate.

In February this year, Viceroy turned its fire on Swedish real estate company Samhallsbyggnadsbolaget i Norden, alleging the “debt-fuelled” residential company had overstated the value of its assets and conflicts of interest on its board. SBB has denied Viceroy’s allegations in press statements.

Some of Viceroy’s criticism centred on the company’s “staggering” debt pile. The short seller calculated SBB’s “loan-to-value” ratio, the industry measure of debt to assets, as almost 70 per cent, if the hybrid bonds it has issued were as debt, rather than equity.

Though this was far above the 46 per cent reported by SBB in the first half of 2022, the company said classing 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 real estate company and Adler’s biggest shareholder — is taking steps to ease pressure on its balance sheet.

As debt markets have cooled, with new corporate bond issuance dropping by 16 per cent in Europe in the first half of 2022, Rolf Buch, Vonovia’s chief executive, told analysts at a recent earnings call that the company would sell off €13bn 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.

Bankers expect other companies to offload property to cut debt to more manageable levels, but while some are stepping back from the market, others are willing to buy.

Heimstaden, the second largest residential real estate company in Europe, spent another €217mn 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 that “fundamentals for residential investments” remain strong.

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

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

Foà at Algebris added that he was wary about the property sector. “Real estate has been leveraging up a lot. They are very, very cyclical.”

Companies are not excessively worried about debt repayments yet, however, because few bonds will mature before the end of 2023 and 2024. “What you will need for more worry to kick in is a catalyst,” said one banker. “If ratings agencies pre-emptively move on someone, if someone has a hard time putting up rents or if they are held back by government regulation.”

But as conditions worsen, groups with less access to cash could struggle to refinance debt. “Maybe that leads to consolidation within the sector, with smaller names getting into trouble and being bought up over the next year or two,” said another banker.

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