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European property markets change gear

Created:
5 August 2008
Written by:
Claer Barrett

London-listed funds set up to invest in European property have three big problems. Number one, European property values are falling. Two, economic worries in the Eurozone are increasing. And finally, three, meddlesome activists are on the march, demanding that assets should be sold to return value to shareholders.

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Credit crunch bites

Mainland Europe is not immune from the effects of the credit crunch, with evidence suggesting a 12-month lag to the misery blighting UK property investment markets. Research released this week by international property consultant Jones Lang LaSalle shows that volumes of European commercial real estate transactions have fallen 38 per cent in a year. Worse, activity in Europe's largest markets of the UK, France and Germany has fallen 50 per cent from a year ago.

As we've seen in the UK, drastically reduced transaction levels directly translate into falling asset values. This means in the next round of reporting, European property funds will suffer dented portfolio values, and reductions to net asset value (NAV), reducing the huge discounts on which many trade.

For those funds with giddying levels of gearing, problems will be exacerbated further (see Germanic Panic; Sector Comment). If loan-to-value banking covenants are breached, this raises the spectre of distressed asset sales which are increasingly being seen in the UK.

Rents remain the only bright spot - but probably not for much longer. European rents are typically pegged to inflation, which has caused sharp rises, but this will eventually be negated by shorter lease lengths.

Activists on The Prowl

For now, property assets are showing good levels of rental returns, and activist investors are snapping up shares on the cheap, arguing that sales should be attempted to return cash to investors.

"In the absence of properly functioning debt markets, investors are looking to get value out of the sector through activism," comments Mark Young, real estate analyst at Oriel Securities.

Unsurprisingly, Laxey Partners has led the way. This week, its directors Robert Ware and Colin Kingsnorth were appointed to the board of Euronext-listed NR Nordic & Russia Properties, which was previously traded on Aim and called Northern European Properties. Laxey is pushing for the company to liquidate assets and return proceeds to shareholders.

Laxey has also acquired a stake in Bulgarian Land Development, which is trading at a 62 per cent discount to NAV. Fellow activists Carrousel Capital and Utilico have built a 50 per cent stake in Equest Balkan Properties, where disposals of ‘non-core’ property assets are set to be announced.

Buyer Beware

This strategy is all very well, but if the activists do manage to force sales, does anyone out there have the money to buy?

"Debt is both less available and more expensive, so many purchasers are unwilling or unable to transact at prices seen in 2007, while vendors are unwilling to reduce expectations," explains Tony Horrell, head of European capital markets at Jones Lang LaSalle. "It may well take another year before debt markets stabilise, and in the meantime we are likely to see increased distressed selling."

This would have the effect of reducing prices further. But the success or failure of future asset sales all boils down to the ability of potential buyers to borrow money. "Selling piecemeal assets should not be a problem, as there is still good evidence of relationship banking on a local basis," Mr Horrell states. "However, trying to sell a big portfolio which needs large amounts of international debt is much more of an issue."

Recessionary Fears

The unease is exacerbated by growing fears of recession hitting the Eurozone economies. The Eurozone has never experienced a single quarter of negative growth since the introduction of the single currency, but future indicators are deteriorating fast.

German investor confidence in July was the most bearish on record, and various surveys have shown that consumer confidence is falling in many European countries.

Strong GDP growth in European accession states such as Bulgaria and Romania has boosted demand for commercial and residential property. However, if recession comes to "Old Europe", the emerging economies will find export demand is reduced, foreign direct investment will dry up, and that their burgeoning current account deficits will be harder to fund. The deep share price discounts to net asset value are likely to continue for some time yet.

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