As the Maltese economy grows from strength to strength, one of its growth drivers remains the property market which has also experienced a booming cycle in recent years. This expansion is reflected in in new issues coming to the bond market. In fact, more than 53 per cent of outstanding debt is issued by companies who are significantly dependent on the Maltese property market.
The current extremely low interest rate environment and the rise of different business sectors has led traditional issuers to issue new bonds and simultaneously attract new issuers to list their bonds for the very first time on the local stock exchange. Indeed, the past two years have been quite a busy period for the local stock exchange with the listing of new bonds, many of which are connected to the real estate sector.
Decisions in relation to the issuance of debt relies on different factors such as the current economic climate, the company’s existing capital structure and also the nature of the projects that would need to be financed. It is evident that in the current macroeconomic landscape, most companies have preferred to raise capital for their projects by issuing fixed coupon bonds rather than equity. The nature of a real estate company is to acquire, develop and operate properties which could be of either residential or corporate nature.
Given that most real estate companies usually acquire the land that needs to be developed, such entities would require a huge upfront investment which is often funded with an element of debt. Interest on this debt is paid during the development stage and the capital is usually repaid as revenue streams start flowing from the eventual sale or renting out of the properties.
In the current macroeconomic landscape most companies have preferred to raise capital by issuing fixed coupon bonds rather than equity
As a result, the issuer will be able to affect any payments to the investors which usually are made in fixed installments. In addition, when a debt instrument such as a bond is secured by the underlying investment property, should the issuer not be able to service its debt obligations, investors can initiate a legal action to take possesion of collateral to recover their investment.
On the equity side, the real estate sector grew marginally from circa six per cent to almost nine per cent over the last five years, and this is a result of two new companies that have been listed on the local stock exchange for the very first time and companies registering an increase in their valuations.
It is quite understandable why equity market exposure to the real estate sector did not grow at the same pace as it did for fixed income. Primarily, the cost of equity is generally higher than the cost of debt, as equity investors are bearing more risk when purchasing a company’s stock as opposed to a company’s bond.
Consequently, equity investors will demand a higher return on their investment than the equivalent bond investors to compensate for the additional risk they are bearing.
In addition, local investors tend to prefer the stability and income generated by bonds compared to the uncertainty linked to dividends and potential growth of equities.
Industry concentration is a very important consideration in the risk management framework of investors. As new bond issues come to the market, many investors tend to invest directly, in order to lock-in the potential coupon with little consideration to the industry exposure that one might be building-up in the process.
Alternatively, one of the key concepts in the management of mutual funds is to ensure industry wide diversification without excessive overexposures compared to the underlying market. This will protect investors should a sectorial downturn occur.
Clayton Scicluna is a portofolio manager at BOV Asset Management Limited.
The writer and the company have obtained the information contained in this document from sources they believe to be reliable but they have not independently verified the information contained herein and therefore its accuracy cannot be guaranteed. The writer and the company make no guarantees, representations or warranties and accept no responsibility or liability as to the accuracy or completeness of the information contained in this document. They have no obligation to update, modify or amend this article or to otherwise notify a reader thereof in the event that any matter stated therein, or any opinion, projection, forecast or estimate set for the herein changes or subsequently becomes inaccurate.
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