Real estate: Europe’s 10-year party is coming to an end

Deutsche Bank’s new headquarters in London was a coveted asset in February, attracting bids of nearly 1 billion pounds ($1.1 billion), but then came the Russian war in Ukraine.

The invasion sent energy and food prices skyrocketing, prompting central banks to unleash the sharpest round of monetary tightening of this century and threatening the foundations of Europe’s decade-long real estate boom.

As Bloomberg notes, public markets have been sounding real estate alarm bells for months, with the Stoxx 600 real estate index down more than 40% this year and hitting valuations not seen since the global financial crisis. But with the bulk of real estate transactions being private, the real impact of the end of the era of cheap money has been slow to emerge, until now.

Land Securities Group plc, the developer of the 16-storey building that will house Deutsche Bank employees in London from early next year, finally concluded the sale this month, agreeing to a price roughly 15% lower than the initial offers made just before the Russia attack. Ukraine.

The deal is a rare indication of the pain that once-hot European property markets are facing and stands out because many sellers don’t even test the market.

famous buildings

Planned sales of iconic buildings such as the Bank of America headquarters in London next to St Paul’s Cathedral have been cancelled, meaning there are few bids to judge the new reality.

In total, about £6 billion of London office shares were pulled from the sale, according to estimates from brokerage CBRE Group Inc.

That may soon change as companies seeking to refinance find their borrowing costs skyrocket. For some, the debt markets are basically closed and there may not be enough money to pay off all past due loans.

Hans Frensen, Head of Research and Strategy at AEW Capital Management LP, estimates a potential refinancing gap of €24 billion ($23.5 billion) over the next three years from secured loans against properties in the UK, Germany and France.

“All of this will inevitably lead to forced sell-offs between commercial and residential property owners,” said Nicole Lukes, a senior researcher at Bayes Business School which produces a semi-annual report on UK property lending.

Costs are rising

Borrowing costs have risen for UK and European property deals

Vonovia SE seems to have started that trend. Europe’s largest public owner is planning to sell more than 13 billion euros of assets to reduce debt after borrowing costs soared and its share price collapsed.

Other real estate companies loaded with cheap credit – including Aroundtown SA, Adler Group SA and Sweden’s SBB – are also trying to offload assets before loans become due.

Debt markets are key

Debt markets are key to real estate. The world’s largest asset class generally tracks what investors earn on government debt – offering a slight premium given the higher risk.

During the negative interest rate years, buyers were willing to accept minimal returns on their investments. But interest rates are rising and even fixed yields on 10-year German bonds have risen by 2.3 percentage points this year.

This pressure comes through the real estate markets. The Deutsche Bank’s London deal shows yields to head office in London have moved to around 4.7% from 4%, according to Bloomberg Intelligence analyst Sue Munden.

The situation in continental Europe would be much worse as yields there have continued to shrink over the past five years, while Brexit has kept London prices largely in check.

performance pressure

European office revenue shrunk to record lows

This is a concern for real estate companies because even small changes have a big impact on valuations when returns are very low. For example, a building with $10 million in rental income would be $100 million less if the yield moved to 2.5% from 2%, a much larger impact than when yields are closer to historical standards.

So far owners are insisting valuations are holding, with Vonovia recently reassuring investors that third-quarter book values ​​are likely to be flat or higher. Real estate research firm Green Street said in a note that the optimism suggested that appraisers were “more behind the curve than we thought possible.”

Rent increases may be one way to bolster ratings, but with painful downturns across the region and rising costs, businesses and consumers are already in distress. In Germany, more than 10% of households were already burdened with housing costs last year, which was before inflation really started.

sensitive values

When real estate returns are low, small changes have a big impact

Sure, the fundamentals of ownership still seem well established. Demand for new space is strong, vacancies are often low and inflation is likely to hamper new supply by preventing construction. Savills Plc estimates that more than 40% of office projects in London due to be built by 2026 are delayed – some by more than a year.

Aside from some extreme cases, debt levels in real estate companies are modest compared to the surplus before the financial crisis.