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Real Estate
Race to the bottom
We expect the supply of real estate to outstrip demand given credit markets are
reluctant to increase property exposure. We believe a new equilibrium must be
found in values. As a weakening economy is biting on rental income, we believe
it's too early to become positive.
Table 1 : Favourites
Favourites Rating Target price Upside
Citycon Buy 2.0 25%
Eurocommercial Properties Buy 27 16%
Prologis European Properties Buy 5.2 77%
Sponda Buy 4.4 41%
Unibail-Rodamco Buy 120 17%
Source: ABN AMRO estimates
Credit markets holding back property
The fundamental problem we see in the real-estate debt market is that there is a substantial
amount of legacy debt, but no new lending. We believe lending costs for high-quality
commercial real estate companies are 150-250bp above Euribor. Also, we expect LTV limits
to be capped to a maximum of 70%, increasing the need for additional equity at refinancing.
So far, markdowns have been limited on the continent, with values declining 1.4% on
average for our coverage universe. On our estimates, continental European property stocks
are trading at a net implied yield of 7.7% – an attractive level, in our view. Still, credit markets
are holding back incremental buyers and a weakening economy is biting on rental income.
Thus, we believe it is too early to become positive, even at current valuations.
Implications for our universe
As a result of tighter funding conditions and the risk of falling income, we forecast property
values for our coverage universe will decline 17% from peak to trough, reducing NAVs by
30%. This should push up LTVs from 45% to 53%, creating a small margin for error. We
believe six of the 22 companies under our coverage are at risk of breaching their covenants.
Our framework
In an environment of sliding property prices and continued pressure on balance sheets, we
focus on companies with European retail exposure and solid balance sheets, and on
“battered” stocks that we believe have a high chance of survival.
Favourites: Unibail-Rodamco, ECP, Citycon, Sponda, Prologis European Properties
For European retail exposure, which predominantly consists of companies sitting on strong
balance sheets (a 35% LTV on average), we prefer Unibail-Rodamco, Eurocommercial
Properties and Citycon. Our most preferred “battered” stocks are Sponda and Prologis
European Properties. Given their discounts to 2010F NNNAV of 59% and 54%, respectively,
we believe both will be able to weather the storm.
Contents
Executive summary 3
Credit markets continue to hold back incremental buyers. We expect markdowns,
which were mostly theoretical in 2008, to become practice in 2009. We favour solid
balance sheets and “battered” stocks that we perceive to have a high chance of
survival.
3
Credit markets holding back property, and vice versa 3
Favourite 5
RBS Real Estate coverage universe 8
We downgrade VastNed OI, NPRO, NSI and Befimmo, and upgrade Klepierre,
Wereldhave and Sponda. Our valuation models incorporate an average drop in
yields of 140bp, reducing NAVs by 30% from peak to trough.
8
Sector performance – A year in the trenches 11
In 2008, the property sector continued its underperformance versus equities,
declining 50% versus -45% for the MSCI Europe. The decline now stands at -76%
versus the peak of February 2007, versus -47% for the MSCI Europe in July 2007.
11
Investment view – Race to the bottom 13
Weakening occupational markets will accelerate writedowns, in our view.
Continental European companies look better capitalised than the sector in general;
still, we estimate about 27% of our universe will breach debt covenants before 2010.
13
Capital structures still the theme for 2009 13
Real estate fundamentals are back? 19
Bank lending – Dutch case study 22
As a result of the tight funding conditions for the Dutch banks, we expect commercial
real estate companies to be faced with more difficult access to loans, stricter
covenants and higher lending costs.
22
Credit market – Finding equilibrium 24
The fundamental problem in the real estate debt market is that there is a lot of
legacy debt, but no new lending. Both factors have the potential to have a dramatic
impact on the commercial real estate market itself.
24
Benelux – Heading into trouble 28
Structural oversupply in the Dutch secondary office market has inhibited past rental
growth but still values appreciated. These gains will be reversed with more
developments coming in to the market and take-up heading for a standstill.
28
The Netherlands: expectations worsen 28
Belgium: not immune 31
France: Buckle up! 33
The French office market decelerated in 2008, with take-up down 10% and
investment volume down 50%. Some 1.4m sqm of speculative office space is
scheduled to hit the market, pressuring occupancy and rents.
33
Paris offices: a difficult year 33
French retail: shopping centres over high street 36
Nordics: First the banks, then the real estate 38
Nordic banks are currently twice as geared to commercial and residential property
as in the 1990s. Banks are looking to reduce their real estate exposure. Interest
rates are some 50bp below the European average, which should be a relative
advantage
38
Sweden: benefits from Riksbank 38
Finland: steady as it goes 40
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