MAPFRE AM analysis: why the real estate sector is falling out of favor on the stock market
Lucas Maruri, Equity Portfolio Manager at MAPFRE AM
After falling 11% so far this year, the European real estate sector is the second worst performer in the Stoxx600 so far this year, second only to the sharp 17% correction seen in commodities.
However, if we analyze the Stoxx600 by company, we see that two real estate companies, AroundTown (-58% YTD) and Samhallsbyggnads (-75% YTD), are the worst performers of all, alongside the disgraced Credit Suisse (-72% YTD).
What happened to the sector?
Traditionally, the correlation between real estate share prices and interest rates has been negative. Put simply, the higher the interest rate, the higher the discount rate (or in other words, the lower the cap rate) applied to companies in the sector to value their net asset value (NAV). This factor alone got the sector off to a bad start at the beginning of the year.
In January, the market seemed to buy the narrative that “interest rates were bottoming out,” but inflationary fears in February pushed the European Central Bank (ECB) to continue its stance that monetary policy tightening still had a long way to go.
In addition, the banking crisis in the United States, which spread to Europe via Credit Suisse, fueled concerns about the availability of liquidity and funding. This reality didn’t help many of Europe’s real estate companies, many of whom are carrying significant debt on their balance sheets.
And it’s no wonder really: in the debt markets, outstanding issuances of companies in the European real estate market sector amounted to 412 billion euros, 63 billion of which mature in the next two years. This reality puts pressure on some companies in the sector, forcing them to accelerate asset sales (which in turn puts downward pressure on prices), cut investments, cut dividends, and/or refinance the aforementioned issues at higher rates. Not surprisingly, the sector’s results were undermined by profit warnings and dividend cuts.
What can we expect from the sector?
The inversion of the sovereign curves indicates a dual reality for the sector. On the negative side, they anticipate a slowdown or contraction in economic activity, which historically has meant a spike in unemployment rates and an erosion of tenants’ ability to pay and buyers’ access to credit.
On the other hand, the inversion of the curve also predicts interest rate cuts in the not-too-distant future. Should they materialize, they could signal a good entry point for a sector where valuations are undeniably low.
We prefer to watch events unfold from the sidelines, as we believe that there are still risks that could prevent stocks in European real estate, real estate investment trusts, and developers from performing well over the next few months.