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Central bankers are rejuvenating financial markets with talk of lower interest rates. Real world tensions from the fastest hiking cycle in a generation abound nonetheless — and nowhere more so than in commercial real estate.
Rate rises have pushed property valuations sharply lower. The rate hikes may have been less aggressive in Europe than the US but further sector strife seems a certainty this year.
What has improved is investor confidence. Though still well below their peak, share prices for listed real estate sectors in New York and Europe have rallied 20 per cent since the start of November, coinciding with a 70 basis point decline in respective 15-year government bond yields. Given a shakeout of distressed owners still appears to be in its infancy that may prove overly optimistic.
The pain point for sectors on both sides of the Atlantic remains office properties. The enduring popularity of working from home means that some 15 to 20 per cent less space is needed. Last year, office vacancies in major US cities were at the highest level since the late 1970s. Some 20 per cent of space was without tenants in the fourth quarter, according to Moody’s.
The situation in Europe is much better. On average, the vacancy rate in major cities was 6.9 per cent in the third quarter of last year, thinks Savills. That is far below vacancies in the global financial crisis.
Still, problems loom. The implosion of Rene Benko’s Signa property empire illustrates the dangers of excess leverage built up in the low rate era.
Refinancing is the biggest challenge. Listed European real estate needs to find new borrowings for around 10 per cent of its outstanding €300bn of debt each year. Add in the unlisted sector and refinancing requirements jump to an estimated €200bn annually.
In northern Europe debt levels look stretched. Germany’s Aroundtown and Sweden’s Castellum, SBB and Pandox are some of the owners that researcher Green Street argues have higher leverage and financing needs this year or next.
Weak office fundamentals and low rental growth mean financing terms have changed. For every euro borrowed in 2020, office owners might now be able to get just 75 cents, reckons Peter Papadakos, Green Street’s head of European research.
That leaves financing gaps to be covered by new equity or asset sales. Valuations at unlisted property owners have been marked down less aggressively, by perhaps half the fall implied by estimates of prices at which property might actually change hands.
A rush for liquidity will simply reinforce how much further these have to fall.
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