HSBC: Worst of the crisis over for European REITs

A recovery for REITs has been helped by loan-to-value ratios remaining more manageable than expected during the crisis, according to the bank’s analysts.

Analysts at London-headquartered bank HSBC believe the worst of the impact of a sharp rise in interest rate rises is behind listed European real estate companies and they are sufficiently well-capitalised to manage further corrections in asset values.

In a paper released on 31 January – focused on Continental European real estate investment trusts – HSBC said rescue operations via equity raisings had not been required to any great extent in the public real estate markets because leverage remained at “manageable” levels and had not increased “as much as expected”.

Average LTV ratios for the Continental European listed property companies it covers are around 41 percent, according to HSBC. The bank added: “We currently do not expect any covenant breaches; when it comes to LTV covenants, almost all companies still have enough scope to cope with further devaluations.”

Optimism that interest rate cuts will materialise in the months ahead has fuelled a significant recovery in most stocks from the lows of the past three years, HSBC said. However, it expects higher interest rate expenses to continue to dampen profitability even after rate cuts, impacting earnings-per-share until 2025.

“Continental European REITs’ reported EPS grew only 2 percent between 2019 and 2022. Based on our estimates, EPS development will be negative, at -8 percent on average, across 2019 to 2025,” the analysts explained.

HSBC also said the market was “still a long way from historical valuations in terms of both [price-to-earnings] and net asset values”. It added this is a reflection that further falls in property valuations and declining earnings are expected.

The bank also warned listed companies in its coverage – which include German residential landlord Vonovia and French retail investor Unibail-Rodamco-Westfield – need to continue to reduce debts and increase rental income to offset the increased interest burden.

“Marginal financing conditions are well over twice as high as the published average conditions for the existing debt books, so the interest burden will continue to rise unless there is a clear absolute reduction in debt,” it explained.

HSBC anticipates NAVs contained in upcoming fourth quarter 2023 valuation reports will reflect that most of the price correction had been accounted for. It explained: “We assume… around 60-70 percent of the total correction will have been processed in the balance sheets.

“So, in our view, the worst should be over. Peak to trough, we assume a correction of around 10-25 percent depending on the region and usage class.”

It also said peak-to-trough asset value declines would be around 20 percent for German residential and European offices, adding the price correction for retail is “largely done”.

Private market performance

Improvement in the listed real estate sector is typically viewed as a precursor to private market performance, making indications of a recovery a positive sign for the industry at large.

In a blog post published on 19 January, data provider MSCI Research reported the MSCI UK IMI Liquid Real Estate Index ended 2023 with year-on-year total returns of 7.5 percent, with a similar performance in its US index. It concluded better performance by private real estate could follow.

“Over the last 20 years, the performance of the liquid indexes has generally serviced as a leading indicator for direct real estate markets,” Brian Reid, MSCI’s executive director explained. “If you believe that public market pricing will lead private, you may [harbour] some optimism for private markets in 2024”.