TEXT-S&P report looks at credit quality in European real estate
June 06 - Strong portfolios and benign funding conditions in the relatively low-geared segment of European real estate make for a stable ratings outlook among rated real estate investment trusts (REITs) and developers in the region. What's more, these factors should support the creditworthiness of issuers in this industry through 2012, says a report published earlier today titled "Rising Debt Costs And Investment Pipeline Uncertainties Threaten Stability Of European Real Estate Sector."
"We do not anticipate a material change to the European real estate sector's credit dynamics before the end of 2012," said Standard & Poor's credit analyst Anna Overton. "On the downside, the opportunity for positive like-for-like rental growth remains subdued because of the generally weak business confidence and declining retail sales volumes across most of Europe. For our portfolio of rated issuers, however, these factors are balanced by a high degree of recurring income, stable funding structures, and opportunities to raise development capital from business disposals as well as marginal equity sources such as scrip dividends."
Over the next two years, we note that rising debt costs and increasingly difficult choices over building an investment pipeline are likely to limit rating upside in the sector. We consider that access to capital and real estate asset management skills will account for the majority of differences in organic growth rates among European real estate companies over the short to medium term.
Although the current mild recession in the European Monetary Union (EMU or eurozone) is likely to continue into the third quarter of 2012, we believe the economy may pick up modestly in 2013. Based on this view, we consider it unlikely that rental yields will increase in 2012, apart from stronger-positioned pockets of letting activity where rent indexation remains valid from an economic and competitive perspective. These pockets are concentrated around landmark retail properties and prime office locations, and include rents that are priced competitively relative to the tenant's overall income.
Other findings in the report are that:
-- In the retail segment, we see a widening gap in rental income and property valuations between high and low quality assets, particularly in the peripheral countries of the eurozone.
-- In the office and logistics segments, prime rents and the take-up of new space are slowing due to the sluggish economic prospects in the region.
-- We see a risk that house builders in the U.K., France, and Germany may releverage their capital structures owing to the relative stability in prices and volumes.
"In our view, the European real estate sector now offers greater visibility of mid-term earnings trends than at any point in the past three years," added Ms. Overton. "This, in turn, is stimulating investor interest, albeit that investors still focus their attention on stronger and more diversified property portfolios.
"We believe the gradual move now evident among real estate managers toward diversifying funding sources through greater access to the capital markets is set to continue. Most of the mid-cap REITs will in our view likely continue with a layer of more flexible revolving bank debt in their capital structures, in order to better manage capital through the investment cycle. This requirement is likely to keep average debt tenors at or below five years, with gradually rising costs of interest-rate swaps exerting further pressure on interest rate coverage. That said, we consider our rated universe to be competitively well positioned to capture the recurring and expanding demand for quality space. This should, in our opinion, translate into stable debt coverage metrics and credit quality over the next 12 months."