Credit investors believe they have found a “once in a decade” trade in the beaten-down bonds of European residential property companies, which are now surging in price.
Fund managers, including UBS and Schroders, are among those who have been buying property companies’ so-called hybrid bonds, hoping to profit from falling interest rates as some of these companies raise fresh capital to ease short-term cash flows.
Hybrid bonds are riskier junior debt without a maturity date and were issued by property developers seeking to bolster their balance sheets when borrowing costs were low.
Credit agencies usually treat them as part equity and part debt, meaning they only partly add to a company’s debt load.
These bonds tumbled in price in 2022 as central banks quickly tightened monetary policy to combat runaway inflation, with some of the most aggressive and indebted developers particularly hard hit. Some issuers also angered investors by not buying back debt at par after prices had fallen.
But with the European Central Bank now cutting rates again, renewed demand for real estate debt is turbocharging riskier, junior debt such as hybrids, say credit strategists and investors.
“This has been a once in a decade trading opportunity” for credit investors, said Zac Swabe, lead portfolio manager on European High Yield at UBS Asset Management.
European real estate bonds make up the largest part of his portfolio, with hybrids the best performers, and he is holding on to these in the hope of further gains.
Among bonds in the sector to have performed strongly this year are three hybrids issued by indebted Swedish developer SBB (Samhällsbyggnadsbolaget), which have all nearly tripled in price so far this year.
A bond issued by Luxembourg-based CPI Property Group has more than doubled in price.
Some of this debt, such as the Aroundtown 3.375 per cent hybrid, offers better yields than other risky securities. That has helped drive performance this year, with investors trying to lock in yields as the European Central Bank cuts borrowing costs, and boosted some fund managers’ portfolios.
“I like to think of it as a reverse ‘Minsky moment’,” said Hugo Squire, high- yield portfolio manager at Schroders, referring the name given to sudden market collapses brought on by a period of speculative activity.
“You either owned enough of these [real estate] names, or you [fell behind your peers],” said Squire. “Real estate hybrids are a big factor in the [wide distribution] of returns among European high-yield funds.”
Squire bought into the sector roughly 18 months ago, when risk was rising and real estate hybrid prices had collapsed to about 30-40 cents on the euro.
At the time, residential property issuers were largely deciding against taking up a standard industry option known as calling the bonds. While hybrids are typically perpetual, this option allows them to return principal to bondholders and refinance with fresh capital.
However, the cash crunch in the sector dissuaded most from doing so. In a number of cases, such as Aroundtown in January 2023, this irritated bondholders and damaged some issuers’ reputations.
The rally in European property bonds also comes after a serious of governance scandals had previously spooked investors in the sector, with serious accounting issues at German landlord Adler rattling the wider market in 2022.
SBB and CPI have both been subject to scrutiny from short sellers.
CPI’s bonds rallied earlier this month after an investigation carried out by law firm White & Case “refuted” allegations of financial impropriety made by US short seller Muddy Waters, while nonetheless recommending a “greater separation” between the property firm and the family office of its founder.
Less than two years after the crisis, many property companies have found themselves back in favour with credit investors.
“There’s a lot more appetite for these instruments by investors now,” said James Vokins, global head of investment grade credit at Aviva Investors. He believes the investor base for these subordinated bonds has broadened since last year. “They’re seen as . . . a bit of extra juice for the portfolio.”
But he added that real estate hybrids had become a “consensus” position for credit investors and said “longer term we’re cautious on these. You’re not getting paid for the . . . [added] risk at current prices.”
Others, such as Julian Marks at Nomura Asset Management in London, caution that prices may not have much further to rise.
He bought some of these real estate hybrids in late 2023, but said companies such as Aroundtown had suffered some reputational damage for not calling the bonds last year.
He also believes many of these businesses still face problems with high amounts of debt against still shaky local real estate markets in central and eastern Europe.
“Not all of the real estate issuers are out of the woods now,” said Marks. “They are still reliant on interest rates falling rather than the [cash flow] improving for them.”
But, for the moment, investor demand remains firm for any high-yield real estate hybrid issuance, should they decide to refinance, according to Henry Holden, executive director on the European debt syndicate desk at Goldman Sachs.
“High quality real estate companies can issue new hybrids now, there’s enough demand.”
Additional reporting by Robert Smith
