The real estate market is facing perhaps its worst year ever, in fact markets and banks are already in code red, because there is talk of losses in the order of billions.
In fact, the worst risk is in the wave of write-downs that, for months now, several analysts have been fearing will happen in 2023, as a result of the ECB’s continuous interest rate hikes.
If the wave were to occur later this year, it would be a catastrophe for the real estate sector. And even in the event of a recovery, the damage would still be unmanageable for many banks.
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The real estate crisis in Europe is getting closer: markets and banks on high alert
The fear of a real estate crisis came initially from the continuous increase in borrowing costs, following the rise in ECB rates.
Add to this the drop in valuations, and we are looking at a $148 billion loss in value.
In fact, European property owners are already bracing themselves for further turmoil. And so are the real estate companies, holders of USD 165 billion of bonds maturing until 2026.
At the moment, only banks are going on the defensive, reducing their exposure to the sector as credit costs rise. Even in mortgage lending alone, banks have found themselves with Annual Nominal Rates above 4%.
And a TAN above 4% means dealing with a mortgage for which one has to pay, in addition to the initial credit, an amount of interest worth 45-50% of the credit itself. Those who found themselves with a fixed-rate mortgage today are in a safe haven if they took it out before January 2022. Those with a variable rate, on the other hand, find themselves with a mammoth instalment.
And that is only in the mortgage sector. If, on the other hand, we talk about consumer or corporate credit, the rising cost of credit has led some companies to have their debt downgraded to junk status, making borrowing even more expensive.
When the real estate bubble bursts: increasingly realistic end of 2023 scenario
The housing crisis is also due to the bubble in house prices and rents, thanks to European hyper-inflation and rising mortgage costs.
And it is this bubble that will blow the entire real estate sector. Although it is still difficult to say how much the sector will suffer, there is no shortage of warnings.
Most recent was the collapse of office values from the City of London to Berlin. With British Land officially losing its place in the FTSE 100 after more than two decades. In turn, the owner of London’s Canary Wharf financial district was downgraded to junk status.
The result is that the market has begun to retrogress in property investment. So much so that the price of prime office buildings in Paris, Berlin and Amsterdam has fallen by more than 30 per cent in 12 months.
And with the abandonment of funds, indebted owners will have to resort to asset sales, dividend cuts in an attempt to downsize companies in view of a more turbulent future.
Because if there is no reduction of debts, let alone borrowing rates, companies will have to pay higher rates when refinancing. Already something is happening, if one looks at the recent collapse of the Swedish real estate company Samhällsbyggnadsbolaget. More than 90% from its all-time high.
And with a debt of $8 billion, used to build a portfolio of over 2,000 properties. And despite the interest of companies such as Brookfield Asset Management, the company was still downgraded to junk status.
So it is happening to others. According to Bloomberg, the majority of high grade real estate bonds are from companies downgraded to junk recently. All this is happening all too quickly. And if the situation continues like this, it would not be unrealistic for the bubble to burst by the end of 2023.
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How the real estate market will fare in a devaluation and crisis scenario
In a scenario of continued devaluation, the real estate crisis could lead to a reduction in the value of commercial real estate in Europe by around 40 per cent, according to Citigroup Inc. analyst Aaron Guy.
According to Max Berger, credit portfolio manager at DWS Investment GmbH, the estimate is optimistic. Many real estate valuations will even need adjustment downwards.
And precisely because of this, many have already said no to further investments in the sector. As was the case with the fund at MAPFRE Asset Management of more than EUR 40 billion.
In the absence of capital, outstanding debts will have to be covered with other borrowings. This time more expensive because they are high risk. Estimation says that, in the face of such a scenario, the owners might have to provide about 50 per cent additional capital. This is due to a potential refinancing rate of 6 per cent. A momentous figure if one looks at the last twenty years.
The question will be whether the owners, in order to refinance the asset, will be able in the long run to meet the conditions of banks and private credit funds lending money at such rates. Because in such a crisis it is easy to become insolvent.
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