Analysis | Short European Real Estate? Beware. So Is Everyone Else
Europe’s big short is getting bigger. Investors have been adding fresh bets against the region’s sunken real estate stocks, anticipating further declines. An abundance of funds putting on similar trades creates its own risks.
Even with the Stoxx Europe 600 Real Estate Index falling nearly 50% from its post-pandemic high, short-selling activity in the sector almost doubled between early March and early April, according to analysts at UBS Group AG. That means lots of investors are borrowing these stocks from other funds, and selling the shares on the assumption it’ll be possible to buy them back cheaper following another plunge.
The increase hit the top 10 most-shorted shares, led by Sweden’s Samhällsbyggnadsbolaget i Norden AB and Luxembourg-based Aroundtown SA, although there were also notable jumps in wagers against French shopping mall operators Klepierre SA and Unibail-Rodamco-Westfield.
This has reinforced European real estate’s position as the most “crowded short” of all sectors across the world, as determined by number-crunching conducted by the quantitative research team at UBS. Crowding happens when you have an abundance of investors of the same type, for example hedge funds using leveraged investment strategies. It can affect stocks, sectors and markets, and applies to active ownership as well as shorting. The retail mania around US retailer GameStop Corp. is a prime example.
It’s not hard to see why levered European real estate is getting cramped with short sellers. Property assets are a clear victim of rising borrowing costs. Meanwhile, the publicly traded sector is small relative to both to the wider European stock market and the region’s privately owned real-estate industry. There may be serious worries about the impact of plunging US office values on the banks that have lent against them. But the US real estate index is large, liquid and has a higher weighting of more resilient subsectors like logistics, data centers and cellphone masts.
Investors have also had fresh reason to price in more downside for Europe’s more indebted names — notably the resurgent worry that central bankers have not yet got a grip on inflation, and therefore interest rates may need to stay higher for longer than might have been supposed a couple of months ago. That threatens yet pricier borrowing costs for property firms over the medium term, crimping free cash flow. It also reduces capital values as these move inversely with yields.
An inflationary environment ought also to be pushing up rents. But it’s not always clear property income will rise enough to compensate for higher financing costs, if it increases at all in some sectors. Retail and second-grade offices face obvious challenges. But even prime European offices may not have seen off the challenge of hybrid working, according to recent research by Bloomberg Intelligence.
In turn, there’s a heightened chance that the more leveraged players could unleash share sales to cut borrowings. That can push down share prices as the market struggles to digest a glut of new stock typically offered at a discount to prevailing market prices. Sweden’s Castellum AB announced a 10 billion kronor ($970 million) rights offer in February. Once one management team has capitulated to the need for more equity — often a job-ending move — it lessens the stigma for others who follow.
But there are risks in betting on another leg down. Firstly, equity issuance may come in fits and starts. Companies will want to pull other levers first, with selling assets the preferred option. Emergency measures will require a hard trigger, such as a potential covenant breach or credit-rating downgrade, or a looming debt maturity that cannot be affordably refinanced. Initiatives to raise capital may well play out over time as debt matures rather than in a sudden wave.
Then there’s the crowding issue. Shorts can be self-reinforcing as falling share prices attract more pessimists. But crowded shorts are also vulnerable to occasional “squeezes” if hedge funds decide to scale back their exposure in the face of unexpected good news, pushing the stock up. The publication of financial results becomes more nerve-wracking than might otherwise be the case. Little-known developer Atrium Ljungberg AB’s first-quarter net loss was only half as big as analysts expected this month, prompting its shares to rally 10% over two days, and the whole Swedish sector 5%.
It didn’t last: The stock is roughly back where it was before the results, the index is now lower. Spikes like that can still be painful forleveraged short sellers even if the downward trend reasserts itself. Hedge funds playing in this corner of the real estate market need to choose their targets carefully.
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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Chris Hughes is a Bloomberg Opinion columnist covering deals. Previously, he worked for Reuters Breakingviews, the Financial Times and the Independent newspaper.