End of easy-money era sparks questions over landlords’ true debt loads

AT ISSUE is more than US$21 billion of hybrid bonds being treated as equity, not debt, under international accounting rules. Last week, the debate around those securities intensified after one of Europe’s largest landlords, Aroundtown, chose not to exercise a redemption option on one of its hybrids and said it would review whether to defer coupon payments.

The decision caused a broad sell-off in real estate hybrid bonds and brought renewed focus to a change in recommended landlord accounting metrics earlier this year. The European Public Real Estate Association (Epra) changed its guidance in March, suggesting that landlords include hybrid bonds as debt in loan-to-value (LTV) ratios, a key financial metric. With the change, rating agencies, accountancy rules and the industry’s main body – which represents both landlords and shareholders – now treat hybrid debt differently from each other. 

In recent years, borrowers have issued the securities at breakneck speed; if they follow the Epra’s recommendation, landlords would see a sudden jump in their relative indebtedness. Landlords, including Aroundtown and Samhallsbyggnadsbolaget i Norden (SBB), have found themselves in the crosshairs of critics who are questioning how they account for their debt. And now short sellers are starting to move in. 

Harm Meijer, founding partner of real estate private equity firm Icamap Advisory, said: “There has always been in real estate an eternal debate about what you do with hybrids. It is really something that has come from loose monetary policy. In a bull market, nobody cares. In a bear market, it matters.” 

The change in recommended best practices was published just as a rapid shift in monetary policy across the continent brought an end to the 10-year bull market for European real estate. Property valuations have begun to fall, and a growing list of publicly-traded landlords are attempting to offload property to avoid having to refinance their borrowings at much higher rates, or to bring down their levels of indebtedness. 

Aroundtown, which is backed by Israeli investor Yakir Gabay and is one of Germany’s biggest real estate issuers, has been criticised by some for reporting a low LTV ratio. This is because it does not include hybrids in its calculations.

Ash Nadershahi, senior analyst at Creditsights, said last month: “Aroundtown reported an artificially-low LTV ratio of 40 per cent. This is because the company does not include hybrids in its calculations, adds in cash from yet-to-be-completed asset sales and, in our view, applies generous assumptions to its property valuations.” He placed a “sell” recommendation on Aroundtown’s hybrids. 

An Aroundtown spokesperson said that, under the new guidance, the landlord’s Epra LTV ratio would be 55 per cent as of June. The metric was included in a company presentation for investors on Nov 24.

However, Aroundtown defended its accounting practices.

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It said: “We see hybrid notes, especially in the current market condition, as an equity instrument as they do not have any default covenants or maturities, are subordinated to debt, and the principal and coupon payments can be deferred perpetually. For the purpose of bond covenants, the perpetual notes are considered as 100 per cent equity. Thus, in times of financial distress, these instruments provide additional security.”

Aroundtown fell 2.2 per cent on Tuesday (Dec 6), its largest decline on the Stoxx Europe 600 Real Estate index.  

Some 12 per cent of Aroundtown’s freely-traded shares are currently on loan, making the stock among the most-shorted in Europe’s real estate market, falling behind only SBB. Castellum, one of the biggest real estate issuers of hybrids, has 11.9 per cent of its shares on loan, making it the third most-shorted landlord on the index.

SBB, for its part, lost almost 70 per cent of its value this year after short seller Viceroy Research said the company was massaging its LTV ratio by issuing hybrids, among other allegations. 

Epra changed its guidelines in March after extensive debate to “respond to a need voiced by investors, analysts and property companies”. To be sure, credit rating agencies have not changed the way they view hybrids, typically counting 50 per cent of their amount as equity when calculating their credit ratings.

With property values falling, scrutiny of landlords’ relative indebtedness is intensifying, transforming the debate about how hybrids should be accounted for from an esoteric accountancy issue into a potential red flag for investors. 

Creditsights’ Nadershahi said that the LTV ratio is a metric “heavily relied upon by investors when analysing real estate firms, but it’s also one that can easily be manipulated”.

He added: “It’s not something that’s been thoroughly scrutinised until this year, but with the increasing risks skewed to the downside in the European property sector, investors have to conduct their own due diligence away from the company-reported number.” BLOOMBERG