Why Sweden’s $41 billion in property debt is alarming Europe
(Bloomberg) — Even in Sweden, few people knew much about Castellum AB. Still, the rapid sale of 40 million shares in the property company earlier this month is seen by some as a harbinger of things to come in the European property market.
Most read from Bloomberg
The seller, M2 Asset Management AB, cited falling market prices affecting its “ability to meet its financial obligations” for the decision. A major owner’s dumping of the shareholding is just the latest episode in a tumultuous year in which Sweden’s real estate companies have seen their market values halved.
There is little expectation of any respite. The sector faces $10 billion in debt repayments next year, with refinancing requirements of about $41 billion by the end of 2026, according to data compiled by Bloomberg.
The financing pressure for Sweden’s property companies is due to their bonds with variable interest rates and short maturities in an environment of rising interest rates. Although this makes the Nordic property market more vulnerable than others in the region, it is being closely watched as a possible litmus test for the rest of the sector in Europe.
Some real estate companies can be left with no other option than to tap the stock market to raise money.
“Under a bad scenario with no thaw in the credit markets, Sweden could be first in line in a series of bailout rights from listed real estate companies in Europe,” said Peter Papadakos, CEO of Green Street. “It would have significant implications for Europe’s listed property sector.”
The Riksbank and the Financial Supervisory Authority have repeatedly warned that the risks of commercial real estate debt pose a threat to the country’s financial stability. The biggest problem is the spillover effect for Swedish banks: real estate lending last year amounted to about two-thirds of the total loan stock in the Nordic nation compared to less than one-third in many major economies in the euro area.
Anders Kvist, senior adviser to the director of the Financial Supervisory Authority, said the watchdog has been warning about the high levels of debt in commercial real estate companies for at least four years.
– Falling property values can trigger a domino effect, said Kvist. “If property values fall, the available collateral on the loan decreases. This can lead to demands for more collateral and in turn force distressed sales.”
Commercial landlords such as Fastighets AB Balder, SBB and Castellum – which report third-quarter results on Thursday – have spent the past decade pursuing a growth strategy in Sweden that relied on bringing in billions of dollars of cheap money from bond investors hungry for yield. It’s a playbook that has been embraced in European markets supported by razor-sharp interest rates and rising property values.
Rising inflation and the accompanying aggressive monetary tightening by central banks have reversed their fortunes. The impact on Sweden’s mortgaged real estate market, one of the world’s foamiest last year, has been swift and brutal. SBB stock fell 81% in 2022. Bonds the length and breadth of the sector have fallen to crisis levels. Balder on Wednesday had its investment-grade credit ratings placed on review for downgrade to high yield by Moody’s Investors Service.
It has become “a bleak combination for many companies in a market where easy money has rewarded them with an aggressive growth agenda,” said Martin Edemalm, a bond portfolio manager at SEB Investment Management in Stockholm. “But now the market has fundamentally changed.”
Swedish property companies must roll over $40.8 billion of maturing bond debt over the next five years, a quarter of which is due in 2023. How they navigate these repayments is seen as crucial for the wider European sector.
“European property companies in general tend to have lower leverage and longer debt maturity profiles than their Swedish peers,” said Edemalm, whose firm manages about 300 billion kroner ($26.5 billion) in bonds. “However, rising interest rates are a clear negative for the asset class so it is reasonable to assume that yield requirements will increase for European property and pressure valuations.”
Why Adler’s Murky Tale Raises Real Estate Concerns: QuickTake
With bond yields – and thus borrowing costs – at prohibitively high levels, trading has become too expensive for some companies. Last quarter, real estate bond sales shrank to 6.3 billion kroner, the lowest since the last three months of 2018. That crisis has issuers scrambling to secure bank loans as their balance sheets creak under the weight of high leverage and falling property values.
Jens Andersson, Castellum’s chief financial officer, said the company is exploring other financing markets beyond traditional mortgages from Nordic banks. He cited the example of US private placements due to their long duration and competitive prices. But even that sector has its hurdles to overcome after the recent turmoil in the UK market.
An alternative option to ease the funding pressure has been to sell assets. SBB unloaded properties worth a total of SEK 6.7 billion during the second quarter and has recently announced additional sales of at least SEK 10.5 billion. In July, Standard & Poor’s warned there was a “one-in-three chance” it could downgrade its ratings on the landlord to non-investment grade.
Those sales have drawn attention to another concern among investors: Sweden’s unusually high levels of cross-ownership, which have previously prompted warnings from credit rating agencies about management risks and potential conflicts of interest. M2 Asset Management sold its stake in Castellum to another landlord, Akelius Residential Property AB.
Property mogul Rutger Arnhult raised eyebrows when he was named CEO of Castellum after first being elected its chairman. Arnhult also controls M2 and is the largest owner of Corem Property Group, which last year joined another of his holdings, Klovern AB, in a $1.7 billion merger. Castellum in turn owns a third of the Norwegian landlord Entra ASA, where Balder is also a partner.
In a report on the country’s financial system in May, the FSA said debt growth in the property sector meant it continued to be “a significant vulnerability to financial stability.” The watchdog added that it closely monitors the debts of commercial real estate companies because they “have often played an important role in financial crises.”
Maria Gillholm, real estate analyst at Moody’s, says the complex ownership networks among Swedish real estate companies “further limit their access to capital, as companies usually focus on protecting their own liquidity in a downturn.”
“Entra, where Castellum and Balder jointly own a majority stake, is a good example,” she said. “In a downturn when you have to take care of your own liquidity and maybe sell assets, it can be tougher to get everyone to support an equity raise.”
The silver lining for money managers like Edemalm is that the sell-off has been so serious that there are now bargains to be had when drilling down into the sector’s various sub-segments, such as higher-yielding properties in office, industrial or logistics space.
The portfolio manager points to euro hybrid debt sold by Balder, Castellum and Heimstaden Bostad AB as examples of top picks.
These segments are “less sensitive to rising interest costs and will benefit from CPI-linked contracts,” the portfolio manager said. “But the most important thing right now is solid balance sheets and strong supportive owners.”
Most read from Bloomberg Businessweek
©2022 Bloomberg LP