Real estate company bonds not performing well, index shows

Written by Ray Clancy

Thursday, 08 July 2010 09:23

Bonds sold by real estate companies are performing the worst compared with the rest of the market amid concerns the slowing economic recovery in the US and Europe will cause more defaults, it is claimed.

Yield premiums of bonds sold by real estate investment trusts, shopping mall owners and office landlords widened 9 basis points, or 0.09%, more than those on other debt in June, and continued to rise this month, according to the latest Bank of America Merrill Lynch indexes.

They also show that the yield gap on real estate bonds widened to an average of 236 basis points more than benchmark government debt, close to the highest spread in six months and up from 223 basis points at the end of May.

The worst performers were ProLogis, the largest warehouse developer, and Jacksonville, Florida based trust Regency Centers Corporation.

Yield spreads are expanding as reports last week showed US employment fell in June for the first time this year and pending home resales dropped 30% in May from the previous month.

‘Real estate bonds are lagging the market as the global economic recovery is weak. It’s uncertain when the property sector will start to turn a corner,’ said Ivan Comerma, head of capital markets at Banc International Banca Mora in Andorra.

Real estate investment trusts, or REITs, account for 17% of bonds in the index. REITs ‘tend to overshoot the broader market when capital markets are volatile,’ according to Craig Guttenplan, an analyst at CreditSights.

He added that real estate fundamentals may still be fragile but spreads make them look cheap and provided there isn’t a double dip recession, they should outperform other bonds later this year.

Bond sales by REITs fell 31% to $4.87 billion in the second quarter from $7.07 billion in the first three months of the year, according to data compiled by Bloomberg. REITs were hard hit in 2007 and 2008 by the drop in property prices and a decline in occupancies and rents fuelled by the worst economic slowdown since the Great Depression.

But it also shows that real estate debt paid higher returns than any other industry in the first half of the year. Notes sold by property companies returned 8.2%, almost double the 4.99% paid by other types of company debt. Property company bonds have returned 1.18% since May 31, compared with 1.32% for all corporate bonds.

Elsewhere in credit markets, indicators of corporate bond risk in the US and Europe are falling. The Markit CDX North America Investment Grade Index of credit default swaps, which investors use to hedge against losses on corporate debt or speculate on creditworthiness, declined 2.1 basis points to 120.65 basis points.

The indexes typically rise as investor confidence deteriorates and fall as it improves. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.