The debt capital markets remain a crucial source of finance for Europe’s major REITs, although smaller investors are also exploring bond options, writes Daniel Cunningham in a Real Estate Capital special report.
Bond issuance is an integral method for raising long-dated, cheap finance at the large-cap end of the real estate investor spectrum.
Europe’s largest listed property companies, including Unibail-Rodamco and Klépierre, run significant bond programmes to fund their activities. While corporate-style securities are an option for the top-tier of real estate investors, there is also evidence that smaller players in the sector are tapping the debt capital markets as an alternative to straightforward bank loans.
“More and more property companies are turning to diversified sources of funding,” explains John Feeney, global head of commercial real estate at Lloyds Bank Commercial Banking. “It is a prudent evolution of companies’ finance and it is a trend that we expect to continue.”
By far the largest issuers of bonds in Europe are the continental European REITs. With Euro interest rates so low, the real estate giants have taken advantage of the capital markets in what one market participant described as a “no-brainer”.
In March, JP Morgan’s European credit research desk published a report which examined the debt structure behind nine of Europe’s largest REITs including Mercialys, Vonovia (formerly Deutsche Annington) and Gecina. The investment bank noted €18 billion of bond issuance from its sample during 2015, up from around €15 billion in 2014 and continuing an upward trajectory from less around €2 billion in 2011.
“Issuance volumes have increased significantly as the sector has taken full advantage of favourable market conditions to diversify their sources of funding,” says JP Morgan European credit analyst Roberto Henriques. “M&A activity in the sector has been a driver and we see further scope for consolidation. Overall, issuance is relatively opportunistic given that we have seen the average cost of debt decrease across the sector.
“The ability to lock in well-priced capital for longer than the average bank loan would allow makes the debt capital markets attractive to REITs,” Henriques adds. “Spreads for longer term wholesale financing are attractive compared to bank financing and there is strong investor demand.”
JP Morgan’s research showed that sector spreads have widened in the last year, broadly in line with the rest of the credit markets. The JP Morgan Real Estate Index widened by 79 basis points, versus a 66 bps widening for the iBoxx Non-Financials Corporate index.
“The larger property companies behave like corporates,” explains Raj Jayaprakash, director in Lloyds Bank Commercial Banking’s corporate DCM team. “They use five-year revolving credit facilities (RCF) and anything longer than that is refinanced into the bond market. For investment grade companies the RCF typically remains undrawn, supports their rating and is used for working capital.”
In March, Unibail-Rodamco announced the successful placement of a €500 million ten-year bond. The note offered a fixed coupon of 1.375 percent and was more than six times oversubscribed, according to the firm. The order book reportedly reached more than €3 billion in less than two hours. As Europe’s largest REIT, Unibail Rodamco had a total of €13.6 billion of debt at the end of 2015, of which JP Morgan estimates 69 percent is Euro Medium Term Note (EMTN) bonds, 7 percent convertible bonds and 12 percent short-term paper.
Hammerson is a prime example of a UK property company which uses securities to fund its investments. Last October, the firm took out a €1 billion bridging loan due 2017 from a club of banks to pay for its share of a major loan portfolio purchase. Hammerson and Allianz Real Estate jointly bought the ‘Project Jewel’ portfolio of Irish real estate loans from Ireland’s National Asset Management Agency.
Shortly after, Hammerson issued a sterling bond to raise £350 million in order to begin paying the loan off. The bridge loan was extended by €500 million in January to fund the purchase of the Grand Central shopping mall in Birmingham. Hammerson subsequently issued a €500 million bond in March to continue to deleverage the bridge loan. The seven-year bond priced at 157 bps over the euro mid-swap rate, tighter than the 165 bps indicative pricing. The bond carries a coupon of 1.75 percent.
Figures provided by research house Dealogic demonstrate the scale of bond issuance across the European real estate sector. The data takes in all real estate companies, not just the REITs, and strips out any commercial paper and notes of less than 18 months.
The figures show that European issuance was less than $10 billion in 2011, but has been above the $30 billion mark for the last three years. There was a dip, however, from $33.6 billion in 2013 to $30.8 billion in 2015. The number of deals has grown though, from 176 in 2013 to 223 last year. In 2016 to date, more than $4 billion of bonds have been issued across 31 transactions.
The data also showed that, on a global scale, the European real estate sector makes less use of the debt capital markets than its US and Asian counterparts. Compared to the $30.8 billion issued in Europe last year, North America had a total deal value of $48.5 billion and Asia had more than $103 billion.
Although bonds are nowhere near as widely used as bank debt across the European real estate space, there have been significant issues. Kennedy Wilson Europe Real Estate (KWE), the listed investment vehicle of US private equity firm Kennedy Wilson, raised €300 million of unsecured finance via a bond issue last November to fund its acquisition drive.
“It extends the maturity of our debt while moving to a more flexible corporate debt structure and maintains an attractive cost of debt, which is accretive to our acquisitions,” KWE president and CEO Mary Ricks said at the time.
At the asset level, secured real estate securities have not become a significant feature of the post-crisis European market. In contrast to the corporate bond investment market, the asset-backed securities investor base is small, and the CMBS investor base is smaller still. The universal wobble in the capital markets during the late summer of 2015 led to uncertainty surrounding CMBS pricing and the few banks keen to launch deals were forced to pull back. Bank of America Merrill Lynch ended the virtual moratorium on CMBS issuance in March when it sold the Taurus 2016-1 DEU German deal, but prospects for the market remain unconvincing.
“There has been a dearth of CMBS issuance given pricing. A while back there were quite a few secured CMBS-type bonds by firms like Intu and Unite. We haven’t seen as much of that lately. Simple bank funding has appealed,” says Lloyds’ Feeney.
UK shopping centre owner Intu Properties sold a secured bond in 2011 with its Trafford Centre mall put up as collateral. It established a secured bond programme in 2013 with £1.152 billion raised through a bond issue and bank loan against four shopping centres with a combined value of £2.3 billion. A further two properties were added into the structure in late 2014. UK student housing provider Unite has also raised finance through bonds secured by its various properties.
“Secured bonds are still viable, but they take a lot of time to structure and there are alternatives in the loan market. The market is certainly not closed but volatility has had some impact,” added Feeney.
Privately-placed bonds have been issued by real estate firms on a sporadic basis. Notes sold directly to selected investors in the private market are a very different instrument to those offered to the public markets, but provide another alternative to bank debt.
In February, UK investor/developer Derwent London raised £105 million through a US private placement, an issue which is exempt under US securities law. The notes are split between 12 and 15-year maturities and the issue was three times oversubscribed.
“As we like to keep a balance between the level of long dated fixed rate debt and revolving bank facilities, we did not have a big capital-raising requirement,” explains Derwent London’s finance director, Damian Wisniewski. “That encouraged us to raise £105 million via the US private placement market, which we had previous experience of in 2013, rather than going for a public bond which usually has a minimum size of at least £250 million.”
The benefit of privately-placed bonds is that the borrower obtains longer-term debt than would be typically available via a bank loan at comparable pricing. In addition, it has the assurance that it knows its creditors.
“With a private placement you know who you are borrowing from. We have four lenders accounting for £205 million across two deals. Relationships are key for us and this structure gives us four relationships that we can manage.”
Real estate firms which lack the necessary scale to launch a corporate-style bond have the option of turning to the retail market, which is open to a wider profile of investors. Since 2012, retail bonds have been rarely issued. Primary Health Properties did a £75 million deal in July 2012, sparking a spate of issues by mid-sized companies including CLS Holdings, Helical Bar, St Modwen, Unite Group and Workspace Group. The last of that clutch of deals was the £50 million bond issued by Manchester’s Bruntwood in July 2013.
Alpha Plus, a private schools group advised by Delancey, has reopened the market with the launch in March of an £80 million, eight-year retail bond secured by five schools and two nurseries. The note had the lowest coupon so far this cycle for a retail deal issued by a property company, at 5 percent. Bruntwood’s deal two and a half years earlier carried a 6 percent annual coupon.
The minimum subscription for Alpha’s notes was £2,000, putting the issue into a different universe of investors than the deals launched by the likes of the big French REITs. For smaller players, the debt capital markets act as a supplement to bank debt, but borrowers are keen to explore all debt-related avenues open to them.