Is the real estate ghost coming back to haunt banks?

Is real estate the next risk coming for banks?

The 33 real estate companies in the STOXX Europe 600 Real Estate Index represents €138bn in market value and sit on total assets of €526bn. These asset values are no longer reflective of the true value which can be seen by the price-to-book ratio which has fallen to 0.7x for the industry suggesting expectations of falling asset values. This dynamic impacts the collateral value for banks and thus tighter conditions for new lending will happen.

As we described in several equity notes there is a deposit game going on in the banking system which in the case of SVB Financial caused a forced fire sale of assets to pay out fleeing deposits which eventually ended with its failure. Real estate companies can be forced into the same situation if the bank wants these firms to reduce debt levels. Over the past 12 months, these 33 real estate companies have spent around 25% of their operating cash flows on paying interest on their debt highlighting that these companies can easily service their debt at this point.

But as several Swedish banks have recently highlighted the debt service abilities of Swedish real estate companies have deteriorated and will continue to deteriorate. Balder, a Swedish real estate owner, was recently downgraded to junk status on its credit. If take the largest real estate company in the index, German-based Vonovia, then the weighted average maturity on its debt is around 6.5 years. This means that if mortgage rates stay here at 3.1% or go higher to the 5% level we had before the financial crisis in 2008, then a significant amount of the operation cash flow will be spent on servicing the debt reducing the value for shareholders.