Only when the tide goes out do you discover who's been swimming naked.

The European real estate debt market has seen record issuance year-to-date, on the back of asset-liability management, the continued transition to unsecured funding sources and M&A activity.

Within the sector, there’s a growing focus on individual segments, as COVID-19 demonstrated that not all real estate investment trusts are created equal. While the struggles of the retail REITs are widely documented (Standard & Poor’s has noted that 50% of retail REITs were already on negative outlook before the pandemic, and that most recent rating actions on issuers have been in the retail segment), some areas have fared better than others. For example, large European residential REITs have broadly seen robust rental growth and stable or upward portfolio valuation lifts. Demand continues to be supported by necessity-based demand, structural undersupply and resultant low vacancy rates. Additionally, across Europe the pandemic has accelerated the growth of ecommerce. Higher corporate inventories boosted the need for logistics/warehouse assets, putting upward pressure on rents and further compressing property yields in the space. The divergence in capital allocation and corporate strategy across issuers (asset purchases, disposals, equity raises, hybrid issuance) is driving the next phase of the European real estate credit story, underpinned by underlying portfolio profiles.

Recent developments in the German residential sector have called into question asset valuations, as one of the country’s leading residential company’s faced allegations of weak corporate governance, poor financial reporting disclosure, excessive development risk and jolted otherwise stable incumbent residential names. We view this as an idiosyncratic risk however, given that investment grade REITs have relatively low Loan-to-Value (LTV) metrics and are far less geared towards development risk, while recent transactions have closed above book value, highlighting the robust assets on balance sheets. While LTV could be pushed higher on aggressive capital allocation policies and debt-fuelled portfolio acquisitions across Europe, issuers are carefully balancing this with a desire to maintain high credit ratings, access to debt capital markets at attractive rates and material equity financing in deals. As the sector continues to grow and navigate the aftermath of the COVID-19 pandemic, we believe issuer and instrument selection will become increasingly important.