Commercial Real Estate Debt Sustained by Central Bank Bond Buying

The office buildings in downtown Europe are empty and shopping malls and main streets are deserted. However, the largest landlords remain afloat during the Covid-19 pandemic as the central bank buys bonds backed by real estate debt.

Some fear the policy will mask long-term pain if workers and shoppers never return their pre-coronavirus numbers.

The stake in Unibail Rodamco Westfield SE, one of the largest investment funds for commercial real estate in Europe and owner of shopping centers, offices, hotels and exhibition centers, is down more than 50% compared to the same period last year.

Unibail’s debts are holding up well, however. The yield on a 5-year bond in the real estate development business was 1.67% on Tuesday, which is more than a full percentage point below the previous year’s figure. The European Central Bank last bought bonds issued by Unibail in the week of January 8th.

Commercial real estate is one of the top sectors that is expected to deteriorate in 2021, according to a survey by the European Banking Authority. New loans to the hardest hit parts have slowed and become more expensive, lenders said.

“In 2020, we noticed a decline in all activities, both in terms of investing and lending to commercial real estate,” said Annette Kröger, Head of Allianz‘s

Real estate business in Northern and Central Europe. “Given the interest rate environment and the high level of liquidity in the market, it has held up despite the world in which we operate.”

Like the Federal Reserve, the ECB has initiated extensive aid measures in the wake of the economic blockades caused by Covid-19. In addition to buying corporate bonds issued by property developers, the company has helped commercial real estate by being a large buyer of covered bonds, a popular European debt issued by banks and through a pool of loans to commercial and residential borrowers has been secured.

Banks typically sell covered bonds to investors. They are often rated AAA as they are backed by both the banks and the underlying collateral. If any of the loans backing the bonds default, the bank will replace the loan with a new, high-performance loan.

The ECB is grabbing covered bonds on the open market as part of its bond purchase program. At the end of 2020, the ECB had more than EUR 290 billion of covered bonds on its balance sheet, equivalent to $ 350 billion. In the first week of January, another 214 million euros were bought.

The ECB can also use them as collateral from banks against ultra-cheap financing. Banks created mountains of “retained” covered bonds last year to serve solely as collateral for ECB loans. In addition, a further EUR 630 billion was held as collateral, compared to EUR 380 billion at the end of 2019.

According to research by the BBVA, the supply of retained covered bonds at German banks almost tripled in 2020.

The use of covered bonds as collateral for ECB loans across Europe increased by more than 60%. An ICE index for euro-denominated covered bond spreads or additional yields versus Treasuries hit a five-year low on January 6th.

“This is definitely a support for the mortgage markets in Europe,” said Agustin Martin, Head of European Credit Research at BBVA. “But it is very independent of real market conditions.”

The long-term impact of the pandemic on property is a key issue. Barclays estimates that around 60% of people in the post-Covid-19 world are expected to work from home more and predicts a decline in office demand of up to 20%.

A similar dynamic is evident in brick-and-mortar stores that got caught in the pandemic, which has already been weakened by the switch to online shopping. The Arcadia Group, a British fashion empire, collapsed in administration in late November in a process that resembled bankruptcy. The shops are the mainstay of the mall.

“More bankruptcies are expected, and the demand for physical retail space is likely to continue to decline,” said Vincent Fokke, head of publicly traded real estate at APG, the Netherlands’ pension fund.

Henrik Stille, portfolio manager at Nordea Asset Management, has sold covered bonds collateralized by more than 10% commercial mortgages. These bonds don’t trade at significantly higher yields than those with higher exposure to residential mortgages, which are rated as lower risk, he said.

A commercial mortgage-backed covered bond from Danske Bank traded minus 0.32% on Tuesday. A similar bond from Danske Bank, tied to a collateral pool that includes only residential mortgages, was down 0.47%. The spread, or the difference between the two, has narrowed in the past 12 months from 0.23 percentage points last January to 0.15 percentage points.

“If you’re not getting compensation for something that is really at greater risk, it’s better to avoid it,” Stille said.

How will the pandemic affect American retailers? While states across the country are struggling to get back in business, WSJ is studying the evolving retail landscape and how consumers might shop in a post-pandemic world.

Write to Anna Hirtenstein at [email protected]

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