(News Bulletin 247) – Having been hard for many years, the sector experienced a small rally in the middle of the summer, thanks to the improvement in the outlook for profits. But the valuation of the sector remains depressed and risks remain.
It’s hard to be optimistic about real estate in a context of rising interest rates. However, European real estate stocks, unloved by the markets, experienced a surprise rally this summer, suggesting that contrarian investors are starting to bet on the aftermath.
Two years of steep declines have made European property one of the favorite sectors for short sellers, as sector valuations and investor positioning have plunged to levels not seen since the 2008 crisis.
Since 2021, the value of the real estate sector in the Stoxx 600 index has halved to around 121 billion euros, but the mood changed in July when profit forecasts for groups in the sector improved.
The sector outperformed its index in July by 10 percentage points ahead of a volatile August, which forced short sellers to buy back securities to cover their positions, as inflows into some exchange-traded funds (ETF) in the sector increased.
Rising earnings expectations
Gerry Fowler, head of European equity strategy at UBS, said bond yields in Europe appeared to reflect a pause in rate hikes by the European Central Bank in September, and that was starting to ease pressure on property companies while by encouraging investors to take an interest in them.
“The situation is not bright for real estate companies and that is why they are trading at a steep discount. Should we expect them to immediately return to full valuation? Probably not. But from the point In terms of the direction of travel, things have started to improve,” he explains.
“Over the past month or two, we’ve started to get some indications of companies’ ability to refocus on earnings growth,” he continues.
Refinitiv data shows earnings revisions turned positive in July, after 15 months of declines, and earnings are now expected to rise 1.4% in 2024, with previous forecasts calling for a slight decline.
“The bet that everything will be rosy”
However, Zsolt Kohalmi, co-managing director of Pictet Alternative Advisors in London, said interest rates in Europe would need to fall by around 150 basis points to revive the market, which is struggling due to a “total pause”. in transactions because buyers and sellers fail to agree on prices.
“This summer, some are betting that everything will be rosy. Inflation will go down, interest rates will go down and some of the structural problems in real estate will be solved,” he adds.
“It’s a scenario. But I don’t know how likely it is. I think it will take longer and we could see another bottom before we have a rebound,” continues the financial intermediary.
According to S&P Global Market Intelligence, borrowed stock volumes, an indicator of short-seller interest in a stock, European property companies and developers have fallen nearly a third since peaking in May and now represent less than 1.7% of the market capitalization of the groups concerned.
Meanwhile, BlackRock’s iShares European Property ETF has seen a 10% rise in inflows since late February, according to data posted on its website.
Most investors remain on the sidelines, however: Bank of America’s survey of fund managers in August showed that investors had capitulated and their positioning had fallen back to 2008 levels, but buying REIT (real estate investment trusts) was the main annoying transaction.
Real estate stocks in Europe are posting a price to book ratio 30% below their 20-year average and at a 49% discount to the market, their deepest discount in 15 years, according to Refinitiv data.
A July report from Natixis’ corporate and investment bank said commercial real estate transactions in Europe fell 60% year-on-year in the first quarter.
Natixis predicts a drop in the value of real estate and sees risks of downgrading the rating of six of the 22 REITs listed, which could complicate the issuance of debt.
A “false start”?
Banks are increasingly vigilant about the deterioration in the quality of the loans they provide to property companies, with key ratios, including the loan-to-value ratio, coming under constant pressure, which could force borrowers to increase their equity or even sell assets.
Societe Generale, which has had no real estate exposure for more than a year, sees the summer rebound as a false start and believes there is no clear direction in sector earnings.
“We don’t like to grab a few pennies in a market with low liquidity. Opportunities can emerge (…) but the image of the sector is far from positive”, for Charles de Boissezon, head of equity strategy at the bank.
A new wave of inflation is one of the risks for real estate. Zsolt Kohalmi of Pictet also said the “biggest unknown” is the next round of refinancing, particularly in the oversupplied office market in the United States: “As first-tier banks rank do not want to refinance market players, no one knows how it will turn out.
“However, for UBS’s Gerry Fowler, European real estate stocks can continue to outperform until the end of the year: “The best ideas are those that are not entirely based on a bullish scenario. (…) When you are sure that things will get better, it is probably already too late to achieve performance”.
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