Real estate players are confident an imminent downturn will be less severe than the financial crisis of 2008 – even as plummeting transaction values spell fresh pain ahead for dealmakers.
Deal prices for transactions currently under way are being slashed by up to 40%, according to Nicole Lux, senior research fellow at Bayes Business School, who spoke to EG from CREFC Europe’s Autumn Conference today. “Discussions here today confirm prices are being chipped by 20-40%,” Lux said.
She said the repricing of those assets will open up “excellent” lending opportunities for banks. She also highlighted opportunities on more challenging assets for the likes of mezzanine lenders and preferred equity backed by private capital, family offices or private debt.
Meanwhile, development financing is forecast to become “very difficult” and will increasingly rely on private capital sources, either in the form of mezzanine or preferred equity.
“The long-term economic forecast assumes interest rates will settle at around 3.5% to 3.75%, which is absolutely sustainable from a lending perspective,” said Lux. “For assets that struggle to meet interest payments at this level, it means asset values have to fall. This will affect specific assets, especially secondary or tertiary.”
The Bank of England has warned that the UK is heading for the longest recession on record, with no recovery expected until the second half of 2024. In its bid to curb inflation, which is predicted to peak at 11%, the bank’s monetary policy committee has raised the base rate to 3%, from 2.25% – the biggest single jump since 1989.
Further rate rises are on the horizon, with the BoE’s chief economist Huw Pill indicating this week that the monetary policy committee will need to take further action.
Peter Cosmetatos, chief executive of CREFC Europe, said there will be a lot of stress in the market and that pockets will “be ugly”, but the upside is there is a diversely funded lending market acting as a backstop.
“The reality is that stress in these situations should be borne by the equity,” he said. “The equity enjoys the super profit in the good times and takes the super risk in the down times. The times when things really fall apart is when credit markets and capital markets are broken too. They aren’t now, which is something to be grateful for.
“People will have to pay more and there will likely be less credit availability, but the market is open and functioning and there isn’t going to be a huge amount of distress based on loans gone sour. People will value that in time, even if there’s a lot of stress and worry about lack of transactional activity and the painful price discovery process for the next few months.”
Ahead of next week’s Autumn Statement, analysts have broadly forecast a peak rate range of between 3.75% and 4.25% barring some new “black swan” event, according to Walter Boettcher, head of research and economics at Colliers. He added that others have predicted a 5% peak, with some expecting the bank to overtighten before exercising a “handbrake turn” in 2023.
Boettcher said: “A look at the latest yield movements suggests that rising yields may be related more to increasing debt costs than to less quantifiable changes in sentiment. After all, the occupational markets remain remarkably stable so far.”
Boettcher added that further repricings will be bifurcated into unleveraged prime assets and leveraged sub-prime properties that also present capex challenges in light of ESG compliance expectations. The latter is tipped as a future source of “unfolding drama” as refinancing becomes trickier.
Savvas Savouri of Toscafund Asset Management said forced fire sales will produce a window for opportunistic prime acquisitions at sub-prime prices. He echoed the sentiment that any fears of a GFC-style fallout should be allayed.
“The reality is that occupational demand will be driven upwards, writ large by rising employment, the latter assured despite interest rates moving higher from here,” he said. “The period we are in is far more akin to 2016 than 2008 or 1990. Those who claim otherwise will come to regret doing so.”
CREFC Europe’s Cosmetatos said the finance market is in a “completely different” situation to the GFC, since real estate will feel the “drip-fed” impact of stress this time round, rather than the limited liquidity in the credit markets that it suffered in the 2008 crisis. Despite significant implications for refinancing and hedging, not all properties will be affected at the same time.
“Values will have to adjust down. But the finance market is in the right place to support that process and benefit from some of the repricing, and meet some of the funding gaps that will emerge. It will be an active market but a functioning one,” he said. “While we face a challenging period, we are not in the position that we were in 2007-09. That’s an important positive.”
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