The rise in overall asset prices, including real estate, has been widely recognised. Less well flagged, though, is the increasing prominence of bonds issued by real-estate companies in European fixed-income markets and indices.
Over the past 10 years, the size of the real-estate sector in Europe’s bond market has increased more than tenfold, from below €15 billion to well over €160 billion. Part of this is attributable to the growth of the broader European corporate bond market, which has more than doubled in size over that time period. But the proportion of debt issued by the real-estate subgroup in the ICE BofAML Euro Corporates Index has also ballooned from less than 1% at the end of 2012 to very close to 6% currently.
This growth was supported by the ECB’s start of the Corporate Sector Purchasing Programme (CSPP) in 2016, which includes real-estate bonds that fit the eligibility criteria.
The sharp increase bears similarities with other sectors that have experienced comparably strong growth over the past 20 years, most notably telecommunication companies in the early 2000s and banks in the years before the financial crisis.
The stories behind the growth of bond issuance in each of these three sectors are different. The telecoms sector saw a sharp increase in debt as it needed to finance the huge bills from 3G licence auctions and investments as well as M&A. The banking sector’s growth was driven by factors like deregulation, derivatives and (again) M&A.
The current low-yield environment is likely one of the main drivers behind the growth in real-estate valuations today, both in the residential market as well as the office market (where the yield gap – the difference between the yield on government bonds and property’s yield – provides a strong incentive for investment). In logistics too we’ve seen strong growth on the back of the trend towards online shopping.
The current growth in bonds issued by real-estate companies is also likely to be linked to the refinancing of securitised (bank) debt, which is replaced by debt with few restrictive covenants. Finally, M&A is again a probable factor, as witnessed recently in Vonovia’s* takeover of Deutsche Wohnen*.
Easy as ECB
Furthermore, yields in Europe are low for longer-maturity debt due to the ultra-low government bond yields and as credit spreads are very compressed because of the ‘hunt for yield’ and the aforementioned buying programmes by central bank.
The ECB currently owns over 25 securities from large issuers like Vonovia and Unibail-Rodamco*. Counting the number of holdings published on the ECB website (as notionals are not provided) suggests about 9% of all corporate bond purchases consist of bonds linked to real estate.
With total corporate bond holdings of €330 billion, this would imply some €30 billion of ECB exposure, which is over 20% of the eligible REIT bonds in the index (as not all bonds are on the purchasing list).
With its corporate bond purchases, the ECB has provided a further stimulus to a sector that is already receiving a large boost from the ultra-low interest rate environment.
History doesn’t need to repeat itself, but if the growth of real-estate bonds in both absolute and relative terms is of any guidance, it should at least be a warning sign for bond investors.
This is something we’re very aware of in our euro credit portfolios, and we continue to scrutinise closely every individual company’s credit profile and management. While we are happy to invest in the sector given the typically more generous spread compensation available, we prefer subsectors like residential and logistics where we believe the longer-term fundamental themes are supportive.
*For illustrative purposes only. Reference to a particular security is on a historical basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.
 Special thanks to Kristian Drew for his help in gathering these numbers.
 See https://www.ecb.europa.eu/mopo/implement/app/html/index.en.html, ‘List of corporate bond securities held under the CSPP/PEPP (end of week)’