European Commercial Real Estate: A mixed bag after recent rally
Luca Evangelisti, Head of Credit Research, Paridhi Garg, Credit Analyst, and Leon Wei, Credit Analyst, explain the reasons behind the commercial real estate crisis in Europe and examine its impact across fixed income and European financial markets.
Investment Manager & Head of Credit Research, Fixed Income
In recent months, the sector has seen a meaningful tightening in credit spreads, although not yet to levels comparable to 2021. This is largely due to improved investor sentiment and a revised outlook on interest rates, rather than any major shift in the underlying fundamentals of the issuers. This more benign market backdrop has opened the door for many companies, like Vonovia and Logicor, to access the bond market again, with strong investor demand leading to reduced premiums on new issuances. This trend of increasing bond issuances could continue, as companies seek to shore up liquidity and manage debt maturities.
However, looking deeper, the picture within the sector is not uniform. While residential and logistics properties are expected to perform better, further valuation declines are expected in the office sector where occupancy remains subdued, partly driven by the pandemic’s work-from-home trend significantly impacting office demand. While higher-quality issuers are returning to the bond market, lower-quality ones remain locked out, facing potential credit restructuring.
We are cautiously optimistic about the sector’s recent rally, but we remain careful with credit selection which continues to be based on rigorous bottom-up credit analysis. Key considerations include: strong asset quality, solid liquidity, ample amount of unencumbered assets, manageable debt maturities, and prudent management practices. In addition, the issuers’ ability to generate cash flow even with higher interest expenses remains a crucial factor in our investment decisions.
How exposed are European banks to the crisis?
The recent sell-offs within financials, particularly those exposed to commercial real estate (CRE), were triggered by larger-than-expected CRE provisions reported by US banks. This fear spread to Europe, where smaller German lenders, like Deutsche Pfandbriefbank, saw significant share price drops due to their high US exposure. Despite PBB’s attempts to reassure investors, their heavy CRE exposure and declining capital buffers raised concerns. We expect continued pressure on small German banks and US regional players.
However, contagion risk to other European banks seems limited. Major banks like Barclays, Société Générale, and Crédit Agricole have low US CRE exposure. Even higher-exposure banks, like Unicredit, are cushioned by strong capital and a low-risk portfolio. Irish banks, with a larger property exposure, focus primarily on domestic residential and retail, mitigating concerns. Overall, while individual cases warrant monitoring, the broader European banking system appears less susceptible to the current US CRE issues.
At Jupiter, across our fixed income strategies, we have minimal exposure to banks with large CRE portfolios. It is important to note that we have no exposure (not even at senior level) to the banks mentioned in the second paragraph.
Looking ahead
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