Swedish real estate – growing in capital markets

The market trends in recent years have been beneficial for the Swedish real estate companies that have enjoyed “the best of all possible worlds” with strong economic growth and low interest rates. This has allowed for rising property valuations thanks to rising rents and lower yield requirements. In addition, the lower interest rates have facilitated debt financing on favorable terms. This, together with the higher valuations that the listed property companies have enjoyed relative to the smaller, privately owned companies, have enabled further growth through acquisitions. Together, the ten largest listed, private or AP-fund owned Swedish property companies now have a combined market value of their property portfolios of around SEK700bn (EUR67bn) and a combined debt burden or around SEK350bn (EUR34bn).

During the recent period of rapid expansion, the traditional bank market has not been sufficient as a funding source for the whole of the Swedish real estate sector. For this reason, the Swedish real estate sector has rapidly expanded in the Swedish corporate bond market in addition to raising funds via both ordinary equity and preference shares. Following the rapid growth, these companies now make up for around to 40 per cent of the Swedish corporate bond market. More recently, some of the companies have also sought funding in euro. The large majority of these bonds has been issued on an unsecured basis. This is different from the traditional bank market where funding is typically provided on a secured basis.

Generally, we regard the real estate sector’s expansion in the bond market as positive, as it has helped the companies to diversify their funding profiles. At the same time, the concentration risk among Swedish bond investors to the property sector has increased. This in turn has increased the real estate companies’ exposure to potential changes in the bondholders’ willingness to invest.

Investors in the European bond market are typically more comfortable with investing in companies that have a slightly lower leverage than has previously been the norm among most Swedish real estate companies. Since these companies therefore have needed to reduce their leverage before entering the euro market, this process has been beneficial for the Swedish bond investors thanks to the companies’ improved credit risk profiles. Also, when issuing EUR bonds these companies tend to lengthen their capital fixing periods and reduce the share of secured funding which is positive for bondholders.

While market conditions generally remain favourable, there are now some clouds on the otherwise bright horizon in the form of an expected gradual slowdown in economic growth, and a potentially rising rate environment. As the operating environment ahead may become more challenging, the importance of a selective investment approach has increased in our opinion. In general terms and from a credit risk perspective, we continue to prefer the companies in the sector which enjoy lower leverage and/or the companies that have demonstrated a willingness to implement meaningful debt reduction measures.

Louis Landeman
Head of Credit Research Sweden at Danske Bank