General Electric Co. is facing bleak returns twice over from ill-timed investments in European real estate markets.
The US conglomerate’s GE Capital financial arm spent billions of dollars in Eastern and Central Europe between 2005 and 2008, becoming one of the biggest buyers late in the property cycle just when prices were peaking. And the value of discounted loans it bought from other investors in 2007 and 2008 has also plummeted.
“With commercial real estate values down sharply from 2007 peaks, GE Capital could still experience sizeable losses on (its real estate) portfolio over the next two years,” said Nicole Parent, an analyst at Credit Suisse.
“GE is unlikely to extend loans that have eroded, which should result in an increase in losses for this portfolio well in excess of its current reserve of $300 million.”
Worries about GE Capital -- the conglomerate’s financing arm that also has a consumer credit business -- are weighing on GE’s share price, and the group is now trading lower than rivals without such financial exposure.
The unit’s real estate portfolio -- worth an estimated $144 billion, $60 billion of which outside the United States -- is taking centre stage as analysts scour the company for any troubles following its credit rating downgrade last week.
A New York-based spokesman said GE would reserve comment on its funding and its real estate strategy until after GE Capital presents to the market on Thursday.
Few opportunistic investors have doled out cash on European real estate debt on the same scale as GE so early in the deleveraging cycle, said Jonathan Short, joint head of property investment management firm Internos Real.
“People are still on the sidelines either because they haven’t been able to secure adequate investor support for the strategy or because they feel risk has not been fully priced in yet,” Short said. “They would certainly argue big debt buys before now were premature,” he said.
Sharp drops in the price of European commercial mortgage-backed securities (CMBS) in the past year lend strong support to this “wait-and-see” strategy.
In its 2009 Global Securitization Annual, Barclays Capital said spreads on most European CMBS had widened to unprecedented levels in the first half of 2008, reflecting weak demand and assumptions of poorer repayment prospects.
Trading on even the strongest ‘AAA’ rated CMBS tranches ranged between low-to-mid 50s of par up to mid-80s of par, Barcap said, a spread so wide that it is expressed in percentage of par rather than usually narrower basis points spreads.
GE’s bricks and mortar investments are also endangered by Europe’s limp economic outlook, particularly those in ailing economic powerhouses of central and Eastern Europe.
GE invested billions of euros in a welter of deals between 2005 and 2008 -- with several big ticket purchases struck just as a European property bubble burst in summer 2007. “You have to look at the correction in Europe as a rolling wave. Everybody who hasn’t yet felt the force of it, should assume they will at some point,” Marc Mogull, head of private equity real estate firm Benson Elliot told Reuters.
“We will be stuck in this muck for a long time. One of the worst things in an investment market is when people with money see no urgency to buy. That’s where we are now,” he said.
According to property broker King Sturge, average commercial property prices in large swathes of Eastern Europe will drop by double figures this year, with maximum price falls ranging between 18% in Turkey to 35% in Slovakia.
Prices could fall by 20% in the main business centers in Romania and the Czech Republic, 25% in Poland and Serbia and 30% in Hungary, King Sturge said.
Analysts broadly expect GE to mount a slick charm offensive on Thursday to convince investors any further trailblazing in the global real estate market would fuel, rather than burn shareholder returns over the longer term.
“Investors will be looking for clarity and reassurance from GE on the fundamentals supporting these investments -- the strength of the underlying tenants and the credit profiles of the borrowers,” Short said.
“But one thing you can be sure of is that that debt is going to be worth less than they originally paid for it two years ago, because virtually everything in real estate is worth less than it was two years ago,” he said. (Reuters)