Real estate’s foundations still look wobbly
Blowout bonds and performance in secondary gloss over the fundamental problems the sector still faces
Whisper it: the real estate sector is back. But the strong primary market reception and the sector’s impressive secondary market outperformance this year belie the same problems that still eat away at large parts of the sector that were prominent before.
P3 Group became the latest real estate company to draw a rapturous response from the bond market this year. The logistics and industrial real estate company on Tuesday opened books on a six year green deal around 40bp wide of fair value. The deal was launched flat or a few basis points through fair value, depending how one judged the yield curve.
The company joins CTP, Logicor and Vonovia in getting great responses from investors this year, while the spreads for the sector had tightened by 22bp as of the end of January even though the wider market traded flat.
Excitement is spilling over into the loans market, too, where lenders say their pipeline of deals is already bigger than all the trades signed in 2023.
But such exuberance does not seem justified — at least, not yet. Of the issuers to have come to market so far this year, residential company Vonovia is the best in its class and came for a much vaunted sterling debut — a market that has a chronic undersupply problem.
The other issurers have been warehousing and logistics companies. Even during the worst and most worrying phases so far of the downturn in the real estate sector, one would be hard pressed to find an analyst or investor claiming that people would not need somewhere to live or that online retail would dry up.
Location, location, location
Other real estate sub-sectors are in a worse position. Ubiquitous working from home has pushed office vacancies to record highs, hitting 19.6% in the US, according to Moody’s. Before Covid 19, the average vacancy rate in the US was roughly 16.8%. In the US alone, around $117bn of office mortgages need to be repaid or refinanced this year, according to the Mortgage Bankers Association.
In Europe, footfall in UK shopping centres was down 5% in January year-on-year, on the back of a 7.4% fall in December, according to the British Retail Consortium. There were smaller decreases in footfall recorded in retail parks and High Streets.
Clearly, the problems plaguing major sections of the real estate business persist.
The other misleading sign of positivity for the real estate sector in the bond market has been that outperformance. A tightening of more than 20bp tighter so far in 2024 has prompted multiple bank analysts to publish — occasionally breathless — missives extolling the investment opportunities in the sector. But the reason real estate has tightened so much is that it was so wide in the first place.
Even after such tightening, real estate borrowers must still pay substantially more than companies with similar ratings in other sectors. That puts a different slant on whether recent real estate issuers are borrowing at tight levels.
P3’s eye popping 43bp tightening during book building on Tuesday still left the issuer launching a trade 92bp wide of where automotive safety company Autoliv, which has the same ratings, sold a bond with a similar maturity last week.
It’s great that some real estate companies are finding a good response in the market this year, but the sector as a whole still has a mountain to climb before it is out of trouble.