Graphic: Bounce in European property stocks: false start or turning point?
24/08/2023 06:10
By Danilo Masoni
MILAN, Aug 24 (Reuters) - It's hard to be bullish about
real estate in an environment of sharply higher interest rates.
Yet unloved property stocks in Europe staged a surprise rally
this summer, suggesting contrarian investors are starting to
look past the worst.
Two years of steep falls have made European property a
short-seller favourite as sector valuations and investor
positioning plunged to levels last seen during the 2008 global
financial crisis.
A gauge of European real estate shares .SX86P has halved
in value to about $131 billion since 2021, but the mood shifted
in July as earnings expectations improved.
The index outperformed the broader market .STOXX in July
by as much as 10 percentage points before a volatile August,
squeezing short sellers just as inflows into some sector-focused
exchange traded funds picked up.
Gerry Fowler, Head of European Equity Strategy at UBS, said
bond yields in Europe seemed to have stabilised on bets the
European Central Bank would hike interest rates just one more
time in September, and that was starting to ease pressure on
real estate companies while encouraging more investor interest.
"Things aren't great for real estate companies and that's
why they are trading at a huge discount. Do we expect them to
immediately go back to full valuation? Probably not. But from a
direction of travel perspective things have started turning the
corner," he said. "In the last month or two we're starting to
get hints of companies' ability to re-focus on profit growth".
Refinitiv data shows earnings revisions turned positive in
July after 15 months of downgrades. Profits are now seen rising
1.4% in 2024, versus previous expectations of a slight drop.
However, Zsolt Kohalmi, co-CEO at Pictet Alternative
Advisors in London, said interest rates in Europe would need to
fall by some 150 basis points to kick-start the market which was
struggling due to a "complete standoff" in transactions because
buyers and sellers are unable to agree on price.
"Some people this summer are making the bet that it's going
to be all rosy. Inflation is going to come down, interest rates
are going to come down and some of these structural problems of
real estate will be solved," he said.
"It is a scenario. But I don't know how likely it is... I
think it's going to take longer and we may have another low
before we have ups," he said.
Shares on loan, a proxy for short interest, across Europe's
listed real estate management and development firms has fallen
by almost a third since a peak in May to below 1.7% of their
market capitalisation, according to S&P Global Market
Intelligence.
Meanwhile, BlackRock's iShares European Property ETF
IPRP.L has seen a 10% surge in inflows from late February,
according to data on its website.
Most investors are still steering clear. Bank of America's
fund manager survey (FMS) in August showed investors had
capitulated with positioning falling all the way down to 2008
levels, but buying REITs (real estate investment trusts) was its
top contrarian trade.
Real estate in Europe is 30% cheaper than its 20-year
average price-to-book valuation and displays a 49% discount to
the market, its biggest in fifteen years, Refinitiv data shows.
A report in July by the corporate and investment banking
unit at Natixis suggested European commercial property
transactions dropped 60% year-on-year in the first quarter.
Natixis is modelling for declines in property values and
sees risks of rating downgrades for six out of 22 REITs, which
could add to challenges of securing debt financing, it said.
Banks are increasingly vigilant about a deterioration in the
quality of their loans to real estate firms, with key ratios
including loan-to-value under sustained pressure, raising the
prospects of covenant breaches which could force borrowers to
top up equity or even sell assets.
Societe Generale, which has had zero real estate exposure
for over a year, views the summer bounce as a false start and
believes there is no clear direction in the sector's earnings.
"We don't like picking up pennies in a low-liquidity market.
Opportunities may emerge... but this doesn't paint a great
picture for the sector," said Charles de Boissezon, Head of
Equity Strategy at the French bank.
Risks for real estate include another wave of inflation.
Pictet's Kohalmi also said the "biggest unknown" was contagion
from the next round of refinancing, especially in the highly
oversupplied market of office buildings in the U.S.: "Because
senior banks don't want to refinance, nobody knows how it will
play out".
For UBS's Fowler, however, European real estate stocks have
room to keep outperforming into year-end: "The best ideas are
when you can't fully justify a bullish case... By the time you
know for sure that things are better it's probably already too
late".
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Earning revisions https://tmsnrt.rs/3KQvciu
Valuation discount https://tmsnrt.rs/3sjwI6l
Summer bounce https://tmsnrt.rs/47FPghp
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(Reporting by Danilo Masoni, editing by Sinead Cruise and
Elaine Hardcastle)
((Danilo.Masoni@TR.com; Reuters Messaging:
danilo.masoni.thomsonreuters.com@reuters.net))