The accounts no longer work out for many real estate investors. The rise in rates has made financing more expensive and, at the same time, debt bonds offer more interesting returns. In this context, many think twice before buying brick. And that has a consequence that almost everyone in the sector seems to have assumed: the value of the buildings will have to drop by force. It is the simplest solution to continue attracting capital. But it is not without its risks and concerns, as the advisory issued last week by the European Systemic Risk Board (ESRB), the European Union’s financial risk watchdog, made clear.
“The rise in interest rates makes the profitability required of real estate rise,” sums up Ines Arellano, director at Merlin Properties, the largest listed real estate company in Spain. “If what is considered a risk-free asset [como los bonos de deuda publica] it gives you a higher return than a few months ago, you should also ask for a higher return from the rest of the investments, real estate included”, he illustrates. “Therefore, a rise in rates implies a decrease in values per euro per square meter,” he concludes.
Correction, adjustment, revision These are words that are repeated these days in all real estate forums to express the same reality: the belief that the price of real estate assets is going to fall throughout Europe, if it is not already doing so. A state of mind that reflects the report Real Estate Market Trends 2023 in Europe published this week by PwC and the Urban Land Institute. The title chosen for this year’s analysis is illustrative: In the eye of the storm. And it collects the feelings of the more than 1,000 professionals in the sector throughout Europe who respond in a survey what their expectations and fears are for the following months.
If the authors of the report highlight the uncertainty that surrounds real estate, some data helps to put black on white what are the fears that cause this situation. 91% of those surveyed this year say they feel somewhat or very concerned about inflation, the same as 89% do with interest rates and 88% with economic growth in Europe. Last year these categories only concerned between 50% and 60% of managers. And, in this context, 86% of those interviewed believe that there will be some impact or a substantial impact on the development of projects because, among other things, three out of four are convinced that the availability of financing is going to worsen and the volumes of real estate investment in Europe are going to recede.
One of the managers in the Spanish part of the study, Antonio Sanchez Recio, partner in charge of the Construction, Real Estate and Housing area at PwC, insists that “it is evident that everything that is happening in relation to the war in Ukraine, such as the The rise in energy prices, inflation or the rise in rates, affects this industry in a very relevant way”. Spain, further removed from the conflict and with better prospects for inflation and energy prices than many European neighbors, has so far weathered the difficulties. But the PwC specialist asks not to be deceived: “The adjustment in the valuation of assets in other European markets will also end up coming,” he says.
Uncertainty
Spain comes from 2022 in which real estate investment was very close to maximum levels. But the feeling is that the last quarter of the year had nothing to do with the previous ones, with a slowdown in activity that seemed impossible just a few months before. “Uncertainty always affects demand,” says the CEO of Merlin, Ismael Clemente, “now we are in a situation of uncertainty and it will moderate as the market breaks somewhere.” His counterpart at Colonial, Pere Vinolas, believes that this evolution may come sooner than expected: “Now there is an expectation of a less serious recession than six months ago and in the world of investment, being very stagnant, we notice indicators of normalization” . The top executives of the two largest REITs (listed real estate investment companies) in Spain met this Wednesday at a round table for the presentation of the PwC report and both focused on the operational progress of their businesses and on the fact that, As long as there is the ability to pass inflation on the rents charged to tenants, real estate investment is a “safe haven value”.
Despite having that asset in their favour, the concern about how the situation will evolve does not disappear. Last week, the ESRB issued a recommendation to the European Union and the national authorities of all the countries of the European Economic Area (which includes the EU partners plus Iceland, Liechtenstein and Norway) to “improve the monitoring of systemic risks with origin in the real estate sector. “An adverse evolution of the commercial real estate sector can have a systemic impact on the financial system and the real economy,” added the agency after carrying out an analysis in which it focused on the exposure of banks to brick and the value of assets.
It is, basically, two communicating vessels: if a building is worth less, whoever has financed that purchase (and has a debt acknowledgment backed by that asset) runs a greater risk. And that ghost haunts Europe, especially since housing in Germany, traditionally considered a very safe investment, began to fall. A Deutsche Bank report highlighted last December that prices had fallen 5% in the country since last spring and predicted that the collapse could reach 20%.
According to Florent Albert, senior director of Structured Finance at credit rating firm Scope Ratings, “the European real estate sector faces several parallel risks in 2023.” He describes at least four: “The prolonged rise in inflation and interest rates, tighter credit conditions, property values under pressure, and structural changes affecting the sector, such as decarbonization or digitization.” “The impact in each country will depend a lot on the monetary policy of the central banks”, highlights the expert. “Germany and the UK are under scrutiny for different reasons,” he adds, “the UK because of rapid rate hikes and macroeconomic conditions; and Germany for its credit policies in the last decade, with cheap financing, above-average leverage and weak protection clauses for lenders.
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