The European Real Estate Association held its 2023 conference at the Landmark Hotel in London this week and still there is one big talking point – interest rates, writes PropertyEU’s Robin Marriott.
At breakfast before the 9am start, international delegates to the annual EPRA conference could be overheard discussing the challenges of the market.
One could easily infer that insufficient trades are happening. Moreover, it is not to their liking that what could be deemed "vulture funds" are circling overhead waiting to swoop on any sellers if maturing loans might lead to sales at low enough prices. But whether that will happen is debatable. For one thing, the gap between would-be sellers and buyers remains, and a pragmatic option for listed property owners might be to just wait things out rather than do something hasty such as sell assets.
It is also clear that valuations as officially recorded in group accounts are out of date. What are they really? 20% less? There is nothing particularly sinister in the lag between published and actual valuations. And companies would prefer to ‘smooth’ valuation downgrades over a period of time if at all possible, rather than causing panic by announcing a huge drop all in one go.
But still. There is a shared belief that the UK listed sector has been much more effective at publicly declaring valuation downgrades than counterparts on mainland Europe, it seems.
These are still tricky times for the listed sector. They are too for private real estate of course, but this gathering of public property companies has to live with the brutality of their battered public share prices for all to see.
The FTSE EPRA/NAREIT Developed Europe Index shows shares of listed European real estate companies have remained depressed this year (though with signs of a modest uptick recently). Europe’s real estate stocks have been battered more than most other types of corporate equities, which is not a badge of honour. However, there is some consolation in saying lower property values and poor market sentiment is at least already baked into existing share prices. Some are hopefully wondering whether they have reached bottom and that there might even be a share buying opportunity in listed stocks.
Apart from “vultures”, it can also be inferred that the other group of buyers in town are more palatable to listed companies - long term investors that believe in a certain product and are not necessarily looking to make a quick profit.
‘It’s all coming down to interest rates,’ is basically how the breakfast group left things after some more chat, because as was later said on the stage, operationally speaking the real estate of listed property companies seems to be performing just fine.
The overheard conversation was a nice scene setter for the public statements to come from the stage 15 minutes later as EPRA CEO Dominique Moerenhout and EPRA chair & Colonial CEO Pere Viñolas Serra made opening remarks.
Colonial’s Viñolas said there was currently ‘too much uncertainty attached to the real economy', and that there was a lack of visibility putting the market ‘on hold for a while'.
Moerenhout added the markets were ‘a bit complicated for the time being’. But he then presented several reasons to be cheerful. Among them is that leverage measured by loan to value (LTV) is around 38% on average in the sector, lower than the 48% at the time of the Global Financial Crisis of 2008.
Another is that the average debt duration is six years and that over 85% of the sector’s debt is fixed term compared to 64% in 2008. Owners of many assets will not be forced to sell due to their loans not coming to maturity.
Delegates are all too aware of the gap between Net Asset Values and share prices. Plus, there is clearly a disconnect between share prices and operational performance, said Moerenhout.
On an upbeat note, he summarised: ‘I think that for the moment investors remain strategically positive and tactically cautious. But we all want the sector to grow. We would like to see IPOs coming to the market and growth of alternative sectors.’
Meanwhile, Viñolas joked he had been losing his voice trying to persuade global investors of the merits of European property. He thinks investors recognise the fundamentals of real estate are working well. ‘The cash flow is there,’ he said.
‘I think they are waiting to see the situation regarding the repricing because for this to happen you need to have a clear view on assumptions for long term interest rates.’
Their comments were followed by insights into what the European Central Bank (ECB) is thinking. These insights came from ECB former chief economist, Peter Praet.
He confided to delegates that if he were still at the ECB, he would be pushing for a further 0.25% rise to 4% when the bank meets next week on September 14. Then again, the ECB might leave rates as they are if it feels further tightening is unnecessary to curb inflation. Basically, the ECB is very scared of many things, said Praet, and is wrestling with what the right ‘signalling’ should be to the financial markets. Money markets are placing around a one-in-four odds on a 0.25% rise.
In an EPRA poll, 58% of the conference delegates said they thought interest rates had not peaked. At the same time, 97% said valuations had not reached bottom either.
Presenting various data on European real estate performance, Cedrik Lachance of research firm, Green Street, showed a chart going back several years demonstrating growth in income on one axis and change in net initial yield on the other. In general, there has been growth in income since 2019. The issue has been change in net initial yields. He said: ‘What’s brought that is the change in interest rates. The problem has been real rates. In terms of changing from negative to sometimes 1-2% positive, valuations have been hit quite materially. Where are we going on values?’
Answering various questions during an afternoon panel session, British Land’s CEO Simon Carter said the company spent a lot of time with investors – some of whom they partner with. He said: ‘The general feeling I am picking up is the cost of capital: it doesn’t matter so much where the rates are, but stability around those rates. If you can price the cost of capital, you can put exit yields on investments.’
‘The other positive is that even though I agree we are in for a period of elevated geopolitical uncertainty and volatility, the UK and Europe did respond well to the challenge of Ukraine, and I think we are seen by investors as a relative safe haven and international investors do want to put money into the UK and Europe. The other parts of the world for that are shrinking.’
When asked about availability of debt in the listed sector, he pointed out the company had its rating recently reaffirmed as A-minus unsecured (from Fitch Ratings in August), which was at the top of the ‘landscape’.
That is something he is pleased about. He said: ‘Availability of debt is fine, but I think it is fair to say it is lower than it was two years ago. Clearly that is the case.’ He added there was a limit to how many revolving credit facilities banks wanted and that currently term facilities were being looked at more and more.
Talking of other types of investors, he said many would struggle to raise debt for 55-60% LTVs.
Margaret Sweeney, CEO of Irish residential company I-RES, said: ‘I don’t see any concerns with operational. Last year, we had a very significant supply shortage in the Irish residential sector and we need to evolve it.’
Ismael Clemente, CEO of Spain’s Merlin Properties, said: ‘The relative attractiveness of the European market – well, the answer for that is growth. That is how we can attract international capital.'
He also said the listed sector needed to grow and one way of doing that was to offer investors more choice by adding in specialist listed property companies that offered alternative sectors.
Svitlana Gubriy, head of indirect real estate at abrdn, said: ‘Effectively our underlying macro-economic assumption is that we will see higher interest rates for much longer. We don't expect interest rates to magically go down within the next 18 months. If it happens, fine. It's going to be nice for us potentially for the industry. But the underlying assumption is that we are going to be dealing with higher interest rates. And the sector - because it is capital intensive - needs to adjust.’
There remains the issue of share prices selling at significant discounts to NAV. So why aren’t the large US opportunity funds taking them over? One person privately said that by the time a premium was added to the offer price, the discount to NAV might have disappeared. Plus, there remains the question whether such takeovers could be financed by high leverage that such funds might require to meet returns.
A separate point is that there has been no real estate IPO so far this year. But at least Life Sciences REIT - which listed in London in December 2021 and moved onto the main market of the London Stock Exchange in December 2022 - is to be added to the EPRA index imminently.
Steve Buller of Fidelity Investments had sympathy for the whole industry: ‘It is an incredibly frustrating time to be a portfolio manager now because it is all macro driven. The fundamentals have actually exceeded expectations, but the stocks don’t seem to care about that because it is all about waiting for that macro pause in interest rates.’
Robert-Jan Foortse of APG said: ‘If you want to invest in the listed space, it is still very much the old traditional sectors.'
His top pick is student accommodation. And the biggest risk the investor faces? ESG.
Next year’s EPRA conference will be held in Berlin.
