The Real Estate market has been on a tumultuous journey over recent decades. The 2007–2008 financial crisis left an indelible mark on the sector, causing property values to plummet and lending conditions to tighten. However, the market has rebounded from the depths of that crisis and has enjoyed a robust period of growth over the past few years. This resurgence has been fuelled by the ready availability of low-cost capital, a robust demand for housing, and a restricted supply. Although the market encountered a minor blip due to the COVID-19 pandemic, the signs pointed towards continued recovery until quite recently. Now, as we enter 2023-2024, there are concerns regarding the financial challenges that could potentially unsettle the market once again.
One of the pivotal factors that can significantly impact Real Estate values is interest rates. This influence extends its reach across commercial Real Estate sectors, encompassing offices, retail, hotels, and logistics, which frequently rely on medium‑term financing. As interest rates climb, the cost of financing becomes steeper, creating hurdles for both developers and investors eager to embark on new projects.
Slowdown in the market
Initially, the upsurge in borrowing costs generally instils caution among developers, leading to hesitance in taking on new projects or expanding their portfolios. Consequently, a slowdown in Real Estate development ensues. Furthermore, developers who have already started projects sometimes find themselves in a predicament as they may be unable to secure funding to see their projects through to completion. This predicament was conspicuous at this year’s Expo Real in Munich, where there was a marked increase in Real Estate developers in search of funding. Similarly, the increase in interest rates takes its toll on the investment side, resulting in plummeting transaction volumes, a reluctance among buyers to expand their portfolios, and a decrease in banks’ risk appetites. The spectre of refinancing existing investments also looms large, as loan terms typically range from 24 to 60 months. Investments that were initially financed in a low-interest rate environment can face, after refinancing, higher debt service requirements that, in the best case, erode profitability and, in the worst case, can decimate a project’s viability.
Interest rate hikes
In the period from 2019 to 2023, the European Central Bank (ECB) increased its key interest rate by 450 basis points, while the Federal Reserve (FED) matched this with an increase of 530 basis points. These rate hikes translated into tangible consequences. Market participants are also witnessing a double effect with
increasing rates and – at the same time – banks tightening their lending criteria. This tightening cycle is therefore unlike any other tightening cycle, since in the past rising interest rates preceded the tightening of lending. This has driven developers and investors away from projects, leading to a sharp decline in investment volumes in numerous countries, and causing prices to decline in specific markets. This prevailing trend exerts pressure on rental rates, though it is imperative to acknowledge that these pressures arise from the inherent inflexibility of long-term commercial real estate leases when juxtaposed with the dynamic nature of interest rates. Prospective tenants find themselves ensnared in a conundrum, facing unyielding conditions, and struggling to absorb the escalating costs of rent. Consequently, many investors grapple with losses and face the challenge of generating the returns necessary to service their loans.
Unstable ground
Consequently, commercial banks, too, find themselves on unstable ground. Interest rate hikes elevate risk levels for banks. Worldwide, loan defaults are on the rise, with commercial Real Estate loans defaults reaching a 14-year high in the United States. Furthermore, a substantial proportion of loans maturing between now and 2025 face the challenge of refinancing, leaving borrowers with limited options – either partly or fully pay down the loans or face foreclosure by the banks. On a global scale, regulatory bodies have introduced safeguard regulations that encompass stringent loan monitoring and reporting standards, aiming to avert a repeat of the catastrophic events of 2007–2008. This intricate web of components can be distilled into a straightforward yet multifaceted realisation: to maintain equilibrium in the Real Estate market, there must be a reciprocal relationship between interest rates, property values, and rental rates.
Looking ahead
In conclusion, the Real Estate market is facing significant challenges in 2023–2024. The emerging financial issues across the world bear a striking resemblance to the factors that contributed to the 2007–2008 financial crisis, prompting concerns of a potential recurrence. However, these challenges also present opportunities for investors with the requisite risk tolerance, as exemplified by the establishment of risk funds preparing for potential market openings. In this dynamic landscape, adaptability, and the ability to seize the opportunities amid challenges will be key to navigating the ever-shifting terrain of the Real Estate market.
