Next year could see a wave of small cap European property companies de-listing from stock markets, predicts Morgan Stanley, as the benefits from operating as a public company continues to polarise according to size.
Reduced liquidity in equity markets as well as selectiveness of bond investors “has reduced the benefit of a listing for the long tail of mid- and small-cap property stocks”, wrote Morgan Stanley analysts Bart Gysens, Christopher Fremantle and Bianca Riemer on Tuesday in a co-authored outlook on European property markets for next year.
Morgan Stanley has also pointed to the high probability of M&A activity next year, particularly in the UK and France, with the latter market triggered by Spanish banks transferring equity or debt holdings to SAREB, the Spanish bad bank.
“In recent weeks we have already witnessed a UK small-cap putting up the ‘for sale’ sign, Local Shopping REIT, a merger between a mid-cap, London & Stamford), and a small-cap, Metric. We expect there to be more of this in 2013,” the research paper continued.
One of the driving forces behind this anticipated wave of property company de-listings is the increasingly uneven cost of debt benefits through corporate bonds and headline revolving credit facility terms between large and small listed property companies.
“Quoted property companies’ marginal cost of debt is tumbling down,” wrote Morgan Stanley. “Marginal cost of debt should go down further for more companies, we think, driving some selective acquisitions, but in general we think the de-gearing from the quoted property sector is set to continue.”
Bond issuance among quoted companies has risen significant this year, although new issuances across Europe have been almost exclusively to refinance existing debt or to push out debt duration, rather than to finance meaningful acquisitions.
By way of example, Morgan Stanley pointed to Unibail-Rodamco, Europe’s largest-listed commercial property company, latest corporate bond, a five-year €500m which priced at a coupon of 1.625% which represented a record low level for a bond issued by Unibail-Rodamco.
Three months prior, Unibail-Rodamco closed a six-year €750m bond, priced with a fixed coupon of 2.25%, and was four-times oversubscribed. The order book raced to €3bn in less than one hour and a half.
This cheap debt sounds counter-intuitive to the high cost of debt environment we are operating post the global financial crisis, but this five-year corporate bond was actually three times oversubscribed – that is, Unibail-Rodamco could have raised €1.5bn at a cost of debt akin to the pre-2007 halcyon days of cheap finance.
“The trend of better access and lower coupons is nevertheless similar for many of the larger companies in the sector,” wrote Morgan Stanley. “This matters as, for most property companies, interest payable makes up a sizeable part of the total cost base; they have a relatively small payroll and are often exempt from paying income and capital gains taxes.”
Investors in these corporate bonds are attracted by net decline of total group leverage at the top end of the listed sector, prime nature of the underlying portfolio, as well of the liquidity in trading stock.
Morgan Stanley wrote: “We think the reduction in marginal cost of debt is driving gearing down rather than up, as more management teams will try to position their company to gain access to the bond market, not just to diversify away from bank lending, but also to borrow more cheaply.
“What we hear from many quoted property companies is that they focus their capital and attention on development, taking risk on the asset side of the balance sheet rather than on the liabilities side.”
Development finance is hard to come by and that is where the quoted companies have an edge, continued Morgan Stanley, where they can achieve higher returns.
“Land Securities’ and British Land’s results to September 2012 highlighted the significance of development gains; these companies reported an 8% and 7% revaluation of the development pipeline, respectively, while their portfolio valuations were moderately down to flat.”
In a second eye-catching forecast, Morgan Stanley also predicted some European property companies will seek to raise equity capital for acquisitions, with the more likely candidates most likely to be those companies which are trading close to or above net asset value (NAV) – again those at the larger end of the spectrum.
Morgan Stanley’s research paper continued: “We do not expect European companies to buy a meaningful amount of assets on their current equity base as many are in deleveraging mode.
“Several property companies have announced disposal programmes, which add up to several billions worth of assets. In addition, even those companies that have access to low coupon bonds are so far refraining from using this cheap debt to make earnings accretive acquisitions.
“Therefore, we could envisage a scenario in which property companies, if they have the appetite and the opportunity to buy a significant amount of assets, could do so at least partially with equity.
“We have already seen this from some of the German companies and some of the London specialists. We think 2013 could be a year in which some of the large quoted property companies also follow that route.”