Shares in European real estate groups are on track for their worst month since the start of the pandemic, as investors bet that weeks of banking turmoil will tighten access to credit and send property valuations plummeting.
The MSCI Europe Real Estate index of large and mid-cap property companies has tumbled close to its lowest level since early 2009 following a 24 per cent decline so far in March, massively underperforming the region-wide Stoxx 600 equity index, which is down 2.4 per cent over the same period.
Analysts and investors have worried for months about the impact of rising interest rates on the commercial real estate sector on both sides of the Atlantic, but those fears have crystallised since the failure of California-based lender Silicon Valley Bank in early March and the forced sale of Credit Suisse to rival UBS a little over a week later.
Some now expect a looming credit crunch will curtail financing to property groups, many of which are already struggling with higher debt costs and flatlining occupancy rates.
Northern European real estate is a “zero-rate addicted sector” and a potential “bubble” that might burst once higher interest rates are properly factored into property valuations, according to London-based Andromeda Capital Management. Rating agency Moody’s this week said refinancing risk in the sector had “significantly increased”, with companies holding debt maturing in the next few years likely to come under particular pressure from higher interest payments.
“Low interest rates have been a subsidy for commercial real estate for 15 years. This is a giant reset for the industry,” said Ron Dickerman, president of Madison International Realty. “All real estate is likely worth less now than it was six or 12 months ago.”
Property valuations are down about 10 per cent from their peak in June 2022, according to the MSCI European Quarterly Property Index. Citigroup forecasts that valuations in western Europe will drop by a further 20 to 40 per cent before the end of next year, while real estate stocks could halve in value over the same period.
Shares in German real estate group Vonovia have fallen 30 per cent since the start of March to the lowest level on record, with Luxembourg’s Aroundtown, France’s Gecina and UK-based Segro down 42 per cent, 13 per cent and 9 per cent in the past four weeks respectively.
Goldman Sachs last week downgraded British Land to “sell”, citing the group’s heavy asset exposure to the City of London, where many companies have adopted hybrid working models since the outbreak of Covid-19.
Agnès Belaisch, chief European strategist at the Barings Investment Institute, said Europe’s real estate sector should brace for “a lot more” interest rate rises given that the European Central Bank, unlike the US Federal Reserve, “seems undeterred by financial stress and confident that the region’s banks are well capitalised and liquid”.
US real estate groups have so far fared slightly better than those in Europe. The MSCI US real estate investment trust index has fallen 8.5 per cent since the start of the month, despite domestic property companies’ reliance for funding on the very regional banks at the centre of investors’ concerns. “In Europe, lending to property groups is concentrated in the larger banks”, Belaisch said.
The composition of the US and European property indices might account for some of the difference in performance, according to Mark Unsworth, head of real estate economics at Oxford Economics. “The US has a much more mature listed real estate universe”, he said, with Reits specialising in alternatives like data centres, self-storage and healthcare comprising a larger share. “Europe will be more exposed to offices, industrial and retail where the relative impact [of higher rates] is expected to be greater”.
Even so, Paul Ashworth, chief US economist at Capital Economics, said that in a worst-case scenario a “doom loop” could develop between smaller banks and commercial property, where worries about banks’ viability leads to deposit flight, forcing lenders to call in commercial real estate loans — “a key part” of their asset base.
Private lenders, too, might find themselves caught out. In December, US private equity group Blackstone limited withdrawals from its $125bn private property fund following a surge in redemption requests.