Advertising space
Why are prices in real estate falling?
Real State

Why are prices in real estate falling?

We are going through very challenging times. The listed property sector, which investors regard as a bond proxy, is being hit by spiking interest rates.
Imagen del autor

17 NOV, 2022

By RankiaPro Europe

featured
Share
LinkedInLinkedIn
TwitterTwitter
MailMail

The listed real estate sector is being affected by rising interest rates. That said, debt leverage is an integral part of the business model of real estate companies.

We are going through very challenging times. The listed property sector, which investors regard as a bond proxy, is being hit by spiking interest rates. That being said, keep in mind that debt leverage is an integral part of property companies’ business model as it allows them to do their job creating value by developing new proprietary assets, by redeveloping older properties, and by structuring specific real-estate portfolios, all while ensuring a generous shareholder return in the form of dividends. Property companies are currently benefiting from an average cost of debt of 1.7% on an average duration of seven years, and their biggest maturities don’t come due until 2027 and thereafter. However, the spike in interest rates has sent the marginal cost of debt up by 450bp on average over the past 12 months. Investors have been scared away from the most heavily indebted property companies and from those with a return on assets close to or below 4%, such as German residential property and logistics. Some property companies have taken out bank debt. One French company did so at 2.5%. But even so, investors prefer to flee the sector, fearing a decline in asset values that would automatically raise debt and ultimately breach banking covenants. All this in spite of solid half-year results, with rental income up, divestment realised with capital gains, indexed leases that provide visibility on future revenue growth, and so on.

Physical real estate will adjust to higher interest rates

Central banks have halted their accommodative policies, but this sudden change of paradigm has not yet truly shown up in physical real estate, which is holding up well to the prevailing glum despite some clouds on the horizon and a likely recession in 2023 that could darken the picture. This change in environment is indeed likely to trigger higher cap rates of physical real estate. But what financial investors seem to have overlooked completely is that we probably will not have an across-the-board increase of the same extent on all markets and types of assets, as valuations adjust far more granularly and the risk premium (i.e., the difference between the risk-free rate and real estate return rate) will depend on the dynamics of each market and type of assets. Rents, vacancy rates, and future supply vs. demand are just as decisive as interest rates in pricing real-estate stocks. Moreover, real interest rates that remain negative or close to zero are an important source of support for real estate.

Advertising space