Deleveraging: effects on markets around the world
In the US and Europe, banks are being forced to deleverage by a combination of the need to comply with Basel III and, in the case of some
European countries, national standards that are even more demanding.
Although the credit crunch has forced property companies in almost all regions to deleverage, Europe stands out as the region in which the problems have been most substantial and where its effects can be expected to be most pronounced and prolonged (table 1, right).
At the other end of the spectrum is Japan, where we believe the protracted deleveraging after the late-1980s boom is now complete. We expect banks to start increasing their lending to real estate.
Most observers’ initial expectations were that deleveraging would force banks and bondholders to foreclose on property loans and sell the underlying property collateral at knock-down prices. Indeed, many private equity groups have raised substantial amounts of equity in anticipation of this happening.
However, in practice, support from central banks and governments and generous spreads between property yields and the cost of debt have allowed banks to avoid becoming forced sellers. Turnover in the property market has remained at very subdued levels (for example in the US,
graph 1, left), and sales that have taken place have typically been of property loans, rather than the underlying assets.
Property companies responded to the credit crunch by raising equity at distressed prices (for example,
in Singapore, graph 2, right), helping to pay back debt as it fell due and reduce leverage to below the maximum levels permitted under debt covenants.
Although this was, in most cases, very dilutive for existing shareholders, we believe the bulk of the property companies we cover around the world have now completed the deleveraging required by the crisis, and anticipate that most future equity issues are likely to be focused on growth opportunities.
Discretionary consumer spending in Australia is being signi cantly limited by deleveraging by consumers (graph 3, left), which has negative implications for Australian REITs that focus on retail property.
This is also an important factor weighing on returns from retail property in the US and Europe. Secondary property suffers the most As property lending has become more scarce, there has been a dramatic cut in the availability of debt on secondary property than there has been on prime, leading to a spreading of the yield gap between prime and secondary property (for example, UK, graph 4, right).
European and US teams agree this gap has some way further to widen, but our European team is more sceptical, expecting it to increase to peak
levels last seen in the early 1980s. Our US team is more sanguine about yields on secondary property falling in the not-too-distant future.
Property companies across the globe have been forced to diversify their sources of funding away from banks. In the US and Europe, insurance
companies are lling the gap created by the banks by offering modestly leveraged loans secured on high-quality property.
In the US and Singapore, property companies have been able to secure substantial amounts of funding from the issue of preferred shares
(US) or perpetual securities that are treated as equity (Singapore).
In China, the absence of debt from conventional sources has forced property developers to raise money from property trusts and informal lending networks, although off-shore bond markets have re-opened since the announcement of the LTRO (long-term refinancing operations).
LTRO is a loan scheme for European banks that was announced by the European Central Bank (ECB) towards the end of 2011 with the aim of helping to ease the eurozone crisis.
When Deutsche Bank property analysts around the world met at the end of November 2011, we were in no doubt that the key downside scenario
was if deleveraging were to follow the pattern set by Japan (graph 5, right). Although equity markets and liquidity have improved, few doubt
that fundamental problems remain.
In the commercial property markets of the US and Europe, the credit crunch led companies to defer or abandon developments to which they were not contractually committed. Allowing for the long lags in development, this is now leading to extremely low levels of supply of new space in both regions. This in turn is helping to maintain or even improve the value of the best-quality property, by maintaining a tight supply for occupiers to rent and for investors to buy.
Martin Allen is a research analyst in the global real estate equity research team at Deutsche Bank.
1 May 2012
30 April 2012
30 April 2012
27 April 2012