European Real Estate Companies Weathering Uncertainties
Standard & Poor’s highlights the uncertainties facing the European Real Estate companies in a new Industry Report Card.
These uncertainties include liquidity issues; potentially inflated real estate valuations and balance sheets; changes in the interest rate environment; and uncertainty regarding future drivers of value creation, S&P says.
That said, most rated European real estate companies have strengthened their financial position in the past few years, continue to post robust operating performances, and remain solid within their rating category.
The majority of these rated companies are the best-in-class among the sector and they will likely outperform the industry because of their above-average fundamentals.
Residential segment faces tougher conditions. The residential segments in Spain, Ireland, and the U.K. are slowing down: As an illustration, mortgage approvals were sharply down (by about 40%) in early 2008 in the U.K. where house prices have decreased by around 3% since the beginning of 2008. The significant slowdown in the Spanish housing construction sector, to 300,000 units expected to be built in 2008 from 800,000 units launched in 2007, is another clear sign of changing market conditions.
Sustainability of current commercial real estate valuations is also at risk. The valuation cycle has also turned for commercial real estate in Europe, and although valuations seem to remain relatively resilient to the financial turmoil in the second half of 2007, the ongoing repricing of risk and the rising interest rate environment are now pushing up yields.
Potential impact for companies: mechanical increase in leverage. As companies have benefited from inflated asset values, many used the headroom on their balance sheets to increase debt to expand their assets. Now, following a slowdown in investment activity, rising interest rates, increasing yields, and widening yield spreads, valuations of real estate portfolios are likely to fall. This will mechanically increase leverage, as defined by the loan-to-value ratio, leading to a narrowing of the company’s financial flexibility, especially when combined with a large, committed development pipeline.
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