Fixed Income Blog

Will Sweden’s Woes Shake Europe’s Real Estate Markets?

03 August 2023

5 min read

Steve Hussey| Head—Developed-Market Global Banks Research

Ali Bendarkawi| Research Analyst—Corporate Credit

Investors are taking fright at commercial real estate risks in Sweden. But we think the situation is less threatening than feared.

Sweden has become the poster child for European property-market volatility. The country’s residential property market has experienced one of Europe’s biggest booms and sharpest reversals in recent years. And Swedish commercial real estate (CRE) markets are facing oversupply, high vacancy rates and rising financing costs.

As a result, the bonds of leading Swedish real estate companies have faced successive credit rating downgrades, sparking fears that CRE troubles will extend to banks and property companies across Europe. We disagree. In our analysis, Sweden’s banks and property companies are mostly well placed to ride out the property-market downturn, and we see fears of a domino effect as overly pessimistic.

Sweden’s Property Market Is Atypical

Investors should take care not to extrapolate Sweden’s property woes across Europe, because Sweden’s financial stability is far more sensitive to CRE than the European average. For example, Sweden’s CRE is one of Europe’s smaller markets, accounting for about 2.8% of the total. But Sweden’s CRE market represents 47% of Swedish GDP, compared with a European average of about 11%.

Sweden’s CRE market is also closely entwined with the Swedish financial system: 47% of CRE bank lending originates from Swedish banks, and a similar proportion of CRE companies’ bonds are owned by Swedish financial institutions and investors. This makes Swedish banks highly sensitive to CRE market developments, given their above-average exposures to the property market (Display).

Sweden Is an Outlier in the European CRE Market

Sweden’s CRE market is dwarfed by Germany, the UK and France’s - but represents 47% of Swedish GDP.

Current and historical analyses do not guarantee future results.
Left display as of December 31, 2022; right display as of March 31, 2023
Source: Eurostat, Statista, Sveriges Riksbank and AllianceBernstein (AB)

Rising interest rates are weighing heavily on the share prices of Sweden’s CRE companies, which have increased their leverage substantially over the last 10 years. Many face much higher debt-service costs (Display), damaging investor confidence.

Swedish CRE Companies Face Painful Financing Resets Within Next Two Years

Out of 13 listed Swedish property companies, 10 have over 20% of their debt refixing at higher rates inside two years.

Current and historical analyses do not guarantee future results.
Percentages shown are adjusted for unutilized credit lines.
As of December 31, 2022
Source: Bank for International Settlements (BIS), company reports and AB

Most Swedish CRE Companies Still Look Robust

Allowing for the sharp increase in financing costs, our analysis suggests that the largest Swedish CRE companies’ earnings before interest and taxes (EBIT) will mostly remain positive over the next two years. This means that only a few would breach their interest-cover ratio (ICR) covenants, and only one would fail to keep its ICR above 1.0× (Display).

Earnings Likely to Support Most Listed Swedish CRE Companies

For half of the listed companies shown, earnings would need to fall by 45% or more for interest cover to fall below one.

Current analyses do not guarantee future results.
Forecasts quoted are S&P Capital IQ consensus, and assume Riksbank policy rate peaks at 4.5% versus prior assumption of 3.75%.
Positive blue bars denote companies that would already have breached their covenants if we adjusted their FY22 ICR to allow for the increased interest burden.
As of May 23, 2023
Source: S&P Capital IQ, company reports and AB

Overall, recent developments don’t point to a drastic CRE scenario. We expect only modest asset-quality deterioration and increased performing loan provisioning at Swedish banks.

Consequently, we think Swedish banks will weather the storm. Crucially, they still have capacity to provide further support to real estate borrowers by taking on more property exposure. Their non-performing loans (NPLs) are low, and loan to value (LTV) ratios are still healthy. Meanwhile, their profitability is strong after successive rate rises helped to widen their net interest margins.

Warding Off Worst-Case Scenarios

Faced with worst-case scenarios, CRE companies could implement an array of measures to mitigate the situation, while banks would likely also offer renegotiated terms and conditions for those companies at risk of breaching their covenants (whether LTV or ICR).

For Swedish banks, even if the estimated value of their collateral were to fall below the loan value, they would still have the option to retain the asset and divest it later once market stresses have eased. This tactic was used successfully in previous crises, and at higher LTV ratios than today.

Bank assets such as higher-yielding property portfolios with inflation-linked rents and leases that oblige tenants to meet buildings’ tax, insurance and maintenance expenses—typical of Nordic light industry, logistics and warehousing—would likely bounce back faster. By contrast, lower-yielding portfolios with no indexation or cost pass-through—typical for Swedish residential—would be much slower to recover and more likely to suffer write-downs.

European Banks Are in Good Shape

Meanwhile, across Europe, we think the risk of contagion from Swedish CRE lending is low. We find that most European banks’ property exposures are manageable, their LTV ratios (averaging about 50%) give them a significant cushion against property losses, and their NPLs are yet to increase.

With a handful of exceptions, European banks’ exposure to US CRE is also modest, representing only a small fraction of their overall US loan books. The majority of European banks also perform well in our financial stress tests based on scenarios such as the GFC and previous banking crises. In the UK, the Bank of England’s recently published Financial Stability Report shows that here too, banks are relatively resilient to a severe stress-test scenario.

Across Europe’s residential property markets, it’s also rare to find the characteristics that have made Sweden’s so volatile: a majority of interest-only loans on variable or short-term fixed-rate deals; no requirement for most households to pay down their debt below 50% of property values; and a relatively low level of fiscal support for householders.

Overall, we think the problems facing Sweden’s banks will impact their profits but not their solvency, and we expect relatively moderate hits to their capital buffers. For Swedish CRE companies, we think the real estate downturn will in most cases be survivable. And for property markets across Europe, we see Sweden as an outlier rather than a sign of things to come.

Additional Contributors: Ravi Dasari | Analyst - European Banks Credit Research

The views expressed herein do not constitute research, investment advice or trade recommendations, and do not necessarily represent the views of all AB portfolio-management teams and are subject to change over time.

About the Authors

Steve Hussey

Steve Hussey is a Senior Vice President and Head of Developed-Market Global Banks Research, covering banks in the US, Canada, Europe, Japan and Australia. Prior to joining the firm in 2000, Hussey spent six years at credit rating agency Fitch IBCA, where he was a director, responsible for the Spanish and Latin American banking sectors. He holds a BSc in business economics and accounting, and an MSc in international banking and finance from the University of Southampton (UK). Location: London

Ali Bendarkawi

Ali Bendarkawi is a Vice President and Corporate Credit Research Analyst covering high-yield and leveraged loan issuers. He joined AB’s Leveraged Finance team in 2018 as an associate portfolio manager and moved to research in 2019. Bendarkawi has covered issuers across a wide range of sectors in Europe and the US, including real estate, industrials, chemicals, energy, technology and media. He joined the firm in 2016 as an associate in New York. Bendarkawi holds a BS in finance from Fordham University. Location: London