The debt markets have become so competitive and bond rates so low that the most well-respected property companies are now able to borrow money effectively for free.
There was a time when the zero-coupon bond was a debt tool available only to the most solvent of governments. Investing in a product that meant the investor actually paid what amounted to an annual fee to hold the asset took a lot of faith, a faith that most corporate issuers struggled to warrant.
Now, however, two real estate companies have joined those ranks. French retail giant Unibail-Rodamco and, closer to home, British Land have issued convertible bonds with, respectively, a negative yield and a zero coupon.
While a convertible bond, in which the bond converts to equity at the end of maturity, generally carries a lower interest rate than more traditional bonds, the British Land issue is the first time a UK real estate company has issued a zero-coupon bond of any type.
The British Land 0% 2020 bond, issued on 2 June, was five times oversubscribed.
The reason the bonds are so attractive is that the conversion price of the bond – the fixed price at which the bond will convert into equity – is set at a significant premium to the current trading price of the company.
The investor therefore is taking a gamble that by buying the bond now they will make a significant return at the end of the bond’s term.
With real estate in the ascendancy as an investment class, larger listed real estate companies have attracted a greater level of confidence from investors in recent months and their finance costs have fallen considerably.
Zero-coupon bonds, because of the discount to their face value at purchase, are proving to be a cheap way to invest and the strength of a business such as BL makes them an investment target.
For investors, convertible issuance by the real estate industry therefore provides a relatively efficient entry into the real estate markets and still charges less by way of a coupon “fee” than most government securities at present – some of which can be negative.
This, combined with a volatile bond market in recent weeks, makes zero-coupon bonds from apparently safe and desirable institutions such as BL look very attractive to investors.
A BL spokesman says: “The bond was well timed,” adding: “Low-yielding bonds reflect the low-interest-rate environment generally.
“This allowed pricing at the tight end of the range, which delivered a zero coupon and a 27.5% premium, resulting in a conversion price of 1103p based on the launch price of 865p.”
For the issuer, the benefits of a zero-coupon bond are more obvious. Described as “free money” in some circles, zero- coupon bonds are not that but are certainly one of the cheapest funding options. BL’s spokesman says: “The bond lowers our overall weighted average interest rate, improving earnings and maintaining the diversity of our sources of finance.”
Not all companies can take advantage of such low coupon rates, however. BL says the bond reflects “the quality and strength of our business, our strong balance sheet and credit rating”. The latter two elements are essential to getting even close to zero coupons on convertibles.
Other firms that could potentially issue zero- or inverse-yielding bonds are Land Securities or Derwent, among others, owing to their size and stature. Although there are no signs that these companies are looking to follow this financing route, the market is prepared to see more in the coming months.
Outside these firms, the scope to attract the supposedly free money that Unibail and British Land have attracted is distinctly limited, even in the world of convertible bonds.
Why buy a bond that doesn’t pay out?
While they may not be getting paid to hold the bond, investors usually pay less than the face value of the price of the bond up front, commonly an amount equivalent to the “missing” interest rate payments. When the bond matures, the face value is paid out, giving a return equivalent to the interest payments and guaranteeing the bond holder a fixed return at a set date. These defined returns are popular with insurance companies and pension funds owing to their certainty and low up-front payments.
What are convertible bonds?
Convertible bonds sit between traditional bonds and equities. They usually bring the benefit of a fixed income payment on a regular basis, like a bond, with the potential benefit of receiving equity in the company at the end of the bond’s term. The conversion price at the end of the term reflects a premium on the company’s share price at issue, and if the company is not trading at that level, the bond will simply pay out the face value price of the bond.
