Everything is looking down for Europe’s worst-hit sector: Real estate.
(Bloomberg) — Everything is looking down for Europe’s worst-hit sector: Real estate.
Facing a double whammy of rising funding costs and a predicted economic slowdown, these highly leveraged stocks are now seen as the most vulnerable corner of European stock markets. Analysts at JPMorgan Chase & Co. issued a fresh warning on real estate, saying a potential further rise in yields poses a “major headwind,” following Citigroup Inc.’s call that the sector could halve in value.
This drumbeat of bleak assessments is happening even as the sector has sustained major losses in recent months. Stoxx 600 Real Estate Index — which tracks around 30 shares — has nursed a decline of more than 40% over the past year, wiping out over a 100 billion euros ($108 billion) in market value. From a valuation perspective, Europe’s real estate equities are trading around levels last seen during the global financial crisis.
The industry is debt-laden largely due to its reliance on mortgages, meaning that central banks’ decision to lift interest rates in order to fight inflation has pushed up servicing costs and spurred funding concerns. Globally, almost $175 billion of real estate credit is already considered “distressed,” Bloomberg reported earlier this year.
Amid a rising risk of recession and tightening credit markets, analysts expect an immediate hit to earnings growth, with commercial real estate seen as a major pain point. Commercial mortgage-backed indexes — and especially lower-quality ones — are showing steep declines.
German real estate firm Aroundtown SA, which invests in commercial as well as residential real estate, is already this year’s worst European equity performer after Credit Suisse AG, having shed more than half its value since mid-January.
“In Europe, investors have not perceived real estate as an inflation hedge and have focused on companies which are the most leveraged,” said Lilia Peytavin, European portfolio strategist at Goldman Sachs Group Inc. “The market’s attention has crystallized on the risk of higher capital costs on companies with vulnerable balance sheets.”
Property firms are also confronting a drop in demand as surging interest rates curtail mortgage applications, and in turn, asset values. The threat of a recession, moreover, could also hinder rental income.
Real estate’s downward spiral started after the Federal Reserve kicked off its rate-hiking cycle a year ago. Since then, the sectoral index’s members have spent around 25% of their operating cash flows on debt interest, Peter Garnry, head of equity strategy at Saxo Bank AS, estimated in emailed comments.
Aroundtown, for instance, gave guidance for 2023 that missed estimates, and on Wednesday it announced the suspension of its dividend payments.
Still, some market watchers like Stephane Deo, chief market strategist at Ostrum Asset Management, say that current debt levels and the unfolding crisis are not as alarming as the global financial crisis of 2008.
“I’m not overly-worried for the sector as a whole,” said Deo by phone. “We are in the eye of the storm, where rents have not gone up yet but interest rates have.”
“With rising interest rates, prices are bound to tick down,” he added. “But this is just an adjustment, not a real estate crash like in 2009.”
–With assistance from Sam Unsted, Michael Msika and Jan-Patrick Barnert.
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