Ten years on from the start of the Global Financial Crisis, the press is full of stories from that apocalyptic episode in market history. The crash showed how harmful the bursting of a debt bubble could be for real estate. The consensus view is that real estate investors are not over-leveraged this time around, but if debt isn’t the problem now, could it be equity instead?
This is a concern expressed by some market participants recently and it is certainly true that equity-rich cross-border players – especially from Asia where yields are structurally lower than in Europe – have been responsible for bidding up prices in Europe this cycle. On average, they are buying at yields 150 bps lower than Europe-headquartered investors. And in Central London, for example, they have helped ensure that pricing has remained relatively firm post-Brexit.
But if these investors withdraw they could leave a hole that other players are unable to fill. Markets such as Warsaw, Central London, Prague, Milan and Dublin are highly dependent on overseas money. While this capital improves liquidity, the potential “flightiness” of cross-border money could also be seen to increase the risk of a price correction in the event of a downturn.
The low levels of debt on many of these transactions mean the kind of forced selling that occurred during the last crisis, and led to tumbling prices, are less likely. But other factors, for example domestic politics, might force a repatriation of capital, leading to that void. (China’s clampdown on foreign real estate investments is a prime example of this.)
As for debt, recent half-year results from Unibail-Rodamco, Europe’s largest listed real estate company, shed some interesting light on the financing market. Their average cost of debt reached a record low of 1.4%, compared with 3.9% a decade ago.
The findings from the recently published IREBS German Debt Report further demonstrate how competitive the European financing market is. The report showed that average loan margins were close to 100 bps in Germany in 2016 and suggested they could fall to double digits by the end of this year.
But with financing costs so low could investors be tempted to overextend, as happened so disastrously a decade ago? Another number from the debt study suggests not: average LTVs in Germany shrank in 2016, to 65.6% from 68.2%. This is not a big move, but it is the direction of travel that is important.
Why have LTVs shrunk? One notion is that the extra equity in the market needs to find a home and therefore investors are using less debt; prudence and the regulatory burden post-GFC must also continue to play a part.
With average LTVs shrinking in Europe’s biggest market and the banking regulations limiting exuberance in the debt market, maybe the current property play by yield-starved equity-rich investors will be the troublemaker at the end of the current cycle.