By Anna Hirtenstein 

Europe's downtown office buildings are empty, and malls and main streets are deserted, yet the biggest landlords are staying afloat during the Covid-19 pandemic thanks to robust central-bank buying of bonds backed by property debt.

Some worry that the policy is obscuring long-term pain should workers and shoppers never return in their pre-coronavirus numbers.

Shares in Unibail Rodamco Westfield SE, one of Europe's largest commercial real-estate investment trusts and the owner of malls, offices, hotels and exhibition centers, are down by more than 50% from this time last year.

Unibail's debt, however, is holding up fine. The yield on a 5-year bond issued by its real-estate development business was at 1.67% on Tuesday, more than a full percentage point lower than a year earlier. The European Central Bank last bought bonds issued by Unibail in the week of Jan. 8, according to public filings.

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

"We've seen a decline in all activity in 2020, in both investing and lending to commercial real estate," said Annette Kröger, head of Allianz's real-estate business in northern and central Europe. "But given the interest-rate environment and the high liquidity in the market, it has held up despite the world we're operating in."

The ECB, like the Federal Reserve, launched extensive relief efforts in the wake of Covid-19 economic lockdowns. In addition to buying corporate bonds issued by property developers, it has supported commercial real estate by being a huge buyer of covered bonds, a popular type of debt instrument in Europe issued by banks and backed by a pool of loans made to commercial and residential borrowers.

Banks generally sell covered bonds to investors. They are often rated AAA since they are backed by both the banks and the underlying collateral. If any of the loans supporting the bonds go into default, the bank replaces the loan with a new, performing loan.

The ECB snaps up covered bonds in the open market as part of its bond-purchasing program. At the end of 2020, the ECB held more than EUR290 billion of covered bonds on its balance sheet, equivalent to $350 billion. It bought another EUR214 million in the first week of January.

The ECB can also take them as collateral from banks in exchange for ultracheap funding. Banks last year created mountains of a flavor of "retained" covered bonds that are used exclusively as collateral for ECB loans. It also held another EUR630 billion as collateral, up from EUR380 billion at the end of 2019.

The retained covered bond supply nearly tripled among German banks in 2020, according to research from BBVA. The use of covered bonds as collateral for ECB loans across Europe rose more than 60%. An ICE index of euro-denominated covered bond spreads, or extra yields over Treasurys, hit a five-year low Jan. 6.

"This is definitely supportive for the mortgage markets in Europe," said Agustin Martin, head of European credit research at BBVA. "But it's very disconnected from real market conditions."

The pandemic's long-term impact on property is a key question. Barclays estimates that around 60% of people now expect to work more from home in the post-Covid-19 world and predicted that office demand will fall up to 20%.

A similar dynamic is playing out for bricks-and-mortar stores, which came into the pandemic already weakened by the shift to online shopping. Arcadia Group, a British fashion empire, collapsed into administration, a process similar to bankruptcy, in late November. Its stores are shopping-mall mainstays.

"There are more bankruptcies expected, and the demand for physical retail space is likely to decline further," said Vincent Fokke, head of listed real estate at Dutch pension fund APG.

Henrik Stille, a portfolio manager at Nordea Asset Management, has sold covered bonds that have collateral consisting of more than 10% commercial mortgages. These bonds aren't trading at substantially higher yields than those with more exposure to residential mortgages, which are considered to be lower-risk, he said.

A Danske Bank covered bond backed by commercial mortgages traded at minus 0.32% on Tuesday. A similar bond from Danske Bank that is linked to a collateral pool containing only residential mortgages was at minus 0.47%. The spread, or difference between the two, narrowed in the past 12 months to 0.15 percentage point, from 0.23 point last January.

"When you don't get compensation for something that really has a larger risk, then it's better to avoid it," Mr. Stille said.

Write to Anna Hirtenstein at


(END) Dow Jones Newswires

January 20, 2021 05:44 ET (10:44 GMT)

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