(Bloomberg) — Even in Sweden, few people knew much about Castellum AB. However, the property company’s rushed sale of 40 million shares earlier this month is now seen by some as a harbinger of things to come in the European property market.
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The seller, M2 Asset Management AB, cited falling market prices that affected its “ability to meet its financial commitments” in making the decision. The dumping of the stake by a major shareholder is just the latest episode in a tumultuous year in which Sweden’s real estate companies have seen their stock prices halved.
There is little expectation of a respite. The sector faces $10 billion in debt payments next year, with refinancing demands of about $41 billion by the end of 2026, according to data compiled by Bloomberg.
The funding constraint facing Swedish real estate companies stems from their floating rate bonds and short maturities in an environment of rising interest rates. While that makes the Nordic country’s real estate market more vulnerable than others in the region, it is being closely watched as a potential litmus test for the rest of the sector in Europe.
Some real estate companies may have no choice but to turn to the stock market to raise funds.
“Under an adverse scenario of no unfreezing in credit markets, Sweden could be first in line in a series of redemption rights issues for listed real estate companies in Europe,” said Peter Papadakos, managing director of Green Street. “That would have considerable implications for Europe’s listed property sector.”
The Swedish central bank and the Financial Supervisory Authority have repeatedly warned that risks stemming from commercial property debt pose a threat to the country’s financial stability. The main concern is the spillover effect for Swedish banks: Real estate loans last year accounted for around two-thirds of the total loan stock in the Nordic nation compared with less than a third in many larger euro zone economies.
Anders Kvist, senior adviser to the director of the Swedish FSA, said the watchdog has been warning about high levels of debt in commercial real estate companies for at least four years.
“Falling property values could set off a domino effect,” Kvist said. “If the value of the property falls, the security available on the loan decreases. This can lead to demands for more collateral and, in turn, force distressed selling.”
Business owners like Fastighets AB Balder, SBB and Castellum, which report third-quarter results on Thursday, have spent the last decade following a growth strategy in Sweden that relied on raising billions of dollars of cheap money from investors in yield hungry bonds. . It is a playbook that was adopted in European markets fueled by rock-bottom interest rates and booming property valuations.
Rising inflation and the resulting aggressive tightening of monetary policy by central banks have reversed their fortunes. The impact on Sweden’s leveraged property market, one of the world’s frothiest last year, has been swift and brutal. SBB shares fell 81% in 2022. Bonds across the sector have fallen to distressing levels. On Wednesday, Moody’s Investors Service placed Balder’s investment-grade credit ratings under review for a downgrade to high yield.
It has become “a grim mix for many companies in a market where easy money has rewarded those with an aggressive growth agenda,” said Martin Edemalm, a bond portfolio manager at SEB Investment Management in Stockholm. “But now the market has fundamentally changed.”
Swedish real estate companies must refinance $40.8bn of bond debt due over the next five years, a quarter of which is due in 2023. How they handle those repayments is seen as critical for the European sector as a whole.
“European real estate firms in general tend to have lower leverage and longer debt maturity profiles than their Swedish peers,” said Edemalm, whose firm manages about 300bn kroner ($26.5bn). in bonds. “But rising interest rates are clearly a negative for the asset class, so it is reasonable to assume that yield requirements will increase for European real estate, putting pressure on valuations.”
With bond yields, and thus borrowing costs, trading at unaffordably high levels, much of the debt financing route has become too costly for some companies. Last quarter, sales of real estate bonds shrank to 6.3 billion kroner, the lowest level since the last three months of 2018. That crisis is leaving issuers scrambling for bank loans as their balance sheets creak under the weight of the high leverage and falling property valuations.
Jens Andersson, Castellum’s chief financial officer, said the company is exploring other funding markets besides traditional mortgage loans from Nordic banks. He cited the example of US private placements because of their long duration and competitive prices. But even that sector has its hurdles to overcome after the recent gold market turmoil in the UK.
An alternative option to help ease the funding squeeze has been to sell assets. SBB divested properties totaling SEK 6.7bn during the second quarter and has more recently announced new sales of at least SEK 10.5bn. In July, Standard & Poor’s warned there was a “one in three chance” it could downgrade the lessor to non-investment grade.
These sales have drawn attention to an additional concern among investors: Sweden’s unusually high levels of cross-ownership, which has previously prompted warnings from ratings agencies about governance risks and potential conflicts of interest. M2 Asset Management sold its stake in Castellum to another owner, Akelius Residential Property AB.
Real estate tycoon Rutger Arnhult surprised when he was named CEO of Castellum after being elected president for the first time. Arnhult also controls M2 and is the largest owner of Corem Property Group, which joined another of his holdings, Klovern AB, in a $1.7bn merger last year. Castellum, in turn, owns a third of the Norwegian owner Entra ASA, in which Balder is also a shareholder.
In a report on the country’s financial system in May, the FSA said rising debt in the real estate sector means it remains “a significant vulnerability to financial stability.” The watchdog added that it is closely monitoring the debt of commercial real estate companies because “they have often played a significant role in financial crises.”
Maria Gillholm, a real estate analyst at Moody’s, says the complex ownership networks among Swedish real estate firms “further limit their access to capital, because firms are typically focused on protecting their own liquidity in a downturn.”
“Come in, where Castellum and Balder together have a majority stake, it’s a good example,” he said. “In a recession, when you have to take care of your own liquidity and maybe sell assets, it might be more difficult to get everyone to support a capital injection.”
The silver lining for money managers like Edemalm is that the sell-off has been so severe that there are now bargains to be had once you delve into the different sub-segments of the sector, such as higher yielding properties in office, industrial or logistics spaces. .
The portfolio manager points to hybrid euro debt sold by Balder, Castellum and Heimstaden Bostad AB as examples of the best options.
These segments are “less sensitive to rising interest costs and will benefit from CPI-linked contracts,” the portfolio manager said. “But the most important things right now are strong balance sheets and strong owners to support it.”
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