End of 2023 and we are experiencing first big insolvencies in real estate market, after more than decade of seemingly blooming stage. With Signa group insolvency we have to ask our selves what is the stage of the industry and is this only a first in the row to experience negative effects of “Minsky moment” which is evolving around corporate bonds.
Namely, exactly two years ago, we were writing about this and anticipated that corporate bonds could be that fatal ingredient which will take real estate market from a blooming phase into fragile market conditions leading to a potential crash of that very market — which is the essence of the Minsky moment theory. (read the full article here).
In these situations the danger zone usually comes from newly invented financing tools, resp. tools exhaustively used. This moves an investment market from a smooth and stable expansion stage over a tipping point into a speculative-driven, highly unstable market environment. This instability in a market can hold quite for some time until it transforms into a rather swift — and all the more damaging — way.
History proved this theory to be true many times. If we focus on the last several decades we will find very clear examples. The take-over business crisis fueled by junk bonds in the 1980s, or the subprime crisis fueled by MBS- and ABS-structures leading to the big financial crisis in 2008 are just two examples of the Minsky Moment induced by a newly invented and/ or exhaustively used financial tool.
End of 2021, using our data driven tools, we noticed that corporate bonds in the European real estate investment markets could exactly be this financing tool which embed a looming crisis framework already during the previous decade of booming real estate markets.
Let’s see how things have developed since then.
Signa Group
During the last few months, we’ve experienced a drama unfolding in the real estate market. Liquidity troubles at Signa Group, once the superstar among real estate investment companies, became public.
Meanwhile, development sites are closed and several entities of the group filed for bankruptcy including Signa Holding GmbH with EUR 5 blns of liabilities as the biggest insolvency case so far in Austria.
On December 8, 2023 an ad-hoc message read as follows:
SIGNA Development Finance S.C.S.: Antrag auf Eröffnung von Insolvenzverfahren für Konzerngesellschaften der SIGNA Development Gruppe überwiegend wahrscheinlich. (Application to open insolvency proceedings for group companies of the SIGNA Development Group is mostly likely.)
The impact of Signa’s crisis on the pricing of SIGNA Development Finance S.C.S bond is evident (here: SIGNA Development Finance SCS 5.5% 21/26).
The Signa crisis is a big take. There is no question about that.
But the concern rises — is this an unfortunate isolated incident?
Or is this an additional step into the direction of a serious market crisis coming along with troubles in the financing tool — real estate corporate bonds’?
Real Estate Bonds Market — DACH Region
Besides standard quantitative analytics tools for these kinds of situations it is necessary to combine also other more advanced tools such as AI based natural language processing in order to see how the market sentiment was in the past period and especially what does it indicate now.
In order to get a feeling on how the real estate bonds market is doing, we analysed bonds-related articles in a German real estate newspaper in a time period from June 30, 2007 to December 9, 2023.
Articles were mainly DACH-region focused. The sample size comprises around 1,400 articles which seems representative for a DACH market examination.
Here is what we can see:
Negative reports connected to real estate bonds literally started to explode two years ago. In fact, the increased coverage of negative topics began right after we published our first article on the Minsky Moment/ Real Estate Bonds (shown as dashed grey line in the timeline in the graph above).
What does speak for deeper troubles in the real estate investment market(at least for the DACH region) is the heavily increased frequency of negative reports on the one hand and the widening scope of involved companies on the other hand.
The steep increase in the ratio of negative reports can be seen in the following graph:
The ratio is close to 18% meanwhile. Though, the increase gets even more significant when comparing the ratio of negative reports within each quarter in the timeline:
Heading for the Next Market Crash? — a Minsky Moment Unfolding
With rising costs of funding, increasing construction costs, changing post-Corona customer behavior, high energy costs and two major military conflicts in the background (to name a few…), a real estate investment market which was booming for over a decade switched into a downturn phase with upward moving yields and hesitating investors.
Whether this current market downturn ends up in a much more serious market crash scenario will depend on how stable the financing framework for real estate bonds proves to be.
In other words, will the bonds market be capable of sustaining its position as (one of the) main drivers of the real estate investment market. A decrease or even a slump in the funding volume will have an obvious, if not devastating, impact on the investment market.
As we saw above, reports about troubles with bonds financing have been spreading out in waves for the last two years. Also, the number of companies causing troubles in bonds financing is widening as well. This could give signals to potential bonds investors to be much more cautious or to shun this financial tool at all.
Adler Group’s chewy attempt to attract investors for its latest bond issuance with a 21% p.a. coupon is a great example and might be the first notion of what is coming in this market.
Another very important aspect is what Minsky said about the stability in the funding market in terms of Cash Flow generating. According to Minsky, there are three types of Cash Flow:
Cash Flow from Operations — Income
Cash Flows which are pre-determined by existing liabilities — Balance Sheet
Cash Flows which come from acquiring or selling assets or from new liabilities put into circulation — Portfolio
As long as capital commitments are met mainly by Cash Flow from Operations, the existing financing framework is quite resilient to internal and external disturbances. This changes gradually and gets very fragile especially when new liabilities are put extensively into circulation resp. Cash Flows are pre-determined by existing liabilities.
Well, the European real estate bonds market faces refinancing requirements of up to EUR 121 blns within the next 3 years (in 2024: EUR 32 blns, in 2025: EUR 44 blns, in 2026: EUR 45 blns) and meeting these needs by Cash Flow from Operations alone seems quite inprobable.
Cash Flows will rather be pre-determined by existing liabilities resp. coming from new liabilities put into circulation. In other words, this is the cookbook for fragile market circumstances.
This and the inherent rise in funding costs will put additional pressure on the market. In any case, this is another strong signal that the real estate market could face not only a downturn but could move into a serious market crisis.
Conclusion
Quantitative market data show us that the real estate market is currently in a downturn. And, data from communication in the market (in this case bonds-related articles) not only support this impression but have been building up respective signals long before quantitative data reveal the real stage of the market.
We already made our case for embedding market communication data in quantitative investment models and using them for predictive analytics (about DDARKS approach combining real estate expertise with data science approach you can read more on our blog).
However due to the strong signals for a further worsening of the investment environment and the anticipated increasing instability in the financing framework, this is now the time for a “all-hands-on-deck” approach.
How to avoid the worst?
In our point of view, it would be wise for companies to prepare for serious cracks in the market and getting those professionals onboard which know how to handle a crisis-situations in all of its aspects.
The combination of real estate restructuring methods and data driven tools can help companies to get quite detailed insights into market developments and their impact on the company itself. So they can adjust their risk exposures in time.
This is valid for enterprises which are not endangered by upcoming potential events yet, e.g. corporate bonds repayments, and choose to implement data driven risk management systems strategically.
In case a company is too exposed, first restructuring processes, such as securing liquidity, negotiating with lenders and retuning funding structures and portfolios are to be triggered. As soon as the situation is stabilized, data driven predictive analytics tools and early risk warning systems are to be implemented in order to be able to have deep insights for all the future market developments and to avoid similar scenarios.
Data driven risk management is quite a new concept and it is maybe hard to grasp from a conventional real estate perspective. However, this approach is the only way for companies to be able to track what is happening (and being talked about) in the market in order to adjust their positions to upcoming events accordingly and in due time.
By the way, an early risk warning system implementation obligation is a part of the European Directive on Restructuring and should have been implemented in all of the respective national legislations until 2021.
This happened in Germany (other countries are still slow to follow-up) but even there the implementation phase is still pending. Nevertheless, failing to implement such systems can result in personal liabilities for management and supervisory board members as well as an increased responsibility for auditors.
References
Risk Management in Booming Real Estate Markets by Christian Schitton published in medium.com/ December 3, 2021
Signa-Holding insolvent — Milliarden-Euro Verbindlichkeiten published in Zeit Online/ November 29, 2023
EQS-Adhoc: SIGNA Development Finance S.C.S. published in APA-OTS/ December 8, 2023 — 20:59 CET
Signa Development steht kurz vor der Insolvenz — Signa Prime offenbar auch published in Immobilien Zeitung/ December 9, 2023
Immobilien Zeitung — Archiv/ June 30, 2007 to December 10, 2023
Adler verlängert Zeichnungsfrist für Anleihe mit 21 Prozent Rendite published in institutional-money.com/ September 21, 2023
Adler platziert zweijährige Anleihe mit 21% endfälligem Zins p.a. published in Immobilien Zeitung/ October 02, 2023
European real estate: companies face jump in bond refinancing in 2024–2026 as investment burden grows published by Scope Group/ October 11, 2023
European commercial real estate remains more robust than US by Kim Politzer and Nina Flitman published by Fidelity Interantional/ April 11, 2023