Behind the glittering facades of Selfridges in London and the Chrysler Building in New York, Austrian real estate tycoon Rene Benko was assembling a financial time bomb.
Mr. Benko's Cigna Group bought stakes in two outstanding assets and built a 27 billion euro ($29 billion) real estate portfolio, but it also took on at least 13 billion euros of debt during years when borrowing costs were almost zero.
“He gobbled up all the cheap loans,” said one European real estate executive.
Cigna's decision to go all out in an era of low interest rates has left it dangerously exposed to a spike in interest rates this year. JPMorgan estimates that at least 4 billion euros of debt at Cigna's two main subsidiaries has floating rates. Rising rates have also driven down commercial real estate values across the market, reducing the value of the assets that secure Cigna's loans.
The central company, Cigna Holdings, filed for bankruptcy protection last week.
The group is facing tough questions about its business practices and valuation, but its collapse is the most visible sign yet of a painful adjustment to rising interest rates across the multi-trillion-dollar global commercial real estate sector.
Property owners have thrived in a world of low interest rates that made real estate investments relatively attractive, but those same high rates have predictably led to liquidations.
“The magnitude of this cyclical reset in property prices is as big as the early 1990s and the global financial crisis,” said Alex Knapp, European chief investment officer at Hines, a global private real estate investment firm with $100 billion in assets. “It's clear this is a big one.”
Unrealized Losses
The era of ultra-low interest rates is over, and real estate owners from small private companies to large public companies are facing rising interest rates, falling valuations and, in many cases, a need for cash to pay down debt.
European property groups are at the center of the issue: Swedish property company SBB struck a deal with Brookfield to raise capital but is now facing angry creditors demanding its money back, while Germany's Adler survived a British lawsuit from creditors this year over its restructuring plan to avoid bankruptcy.
Many property owners are facing unrealized losses: Tom Leahy, executive director of MSCI Research, estimated in September that about 50% of commercial property assets in London are now trading below their purchase price. New York has fared better, with only one in five assets losing value, but many office owners are facing huge losses.
Owners will do everything in their power to stop losses from materializing. Dealings have stalled as official valuations, which rely on evidence from other transactions and tend to lag market realities, have led to a slowdown: The value of completed deals in Europe and the U.S. fell more than 50% in the third quarter from a year earlier, according to MSCI.
“Sellers aren't going to sell something unless they have to. Buyers aren't going to buy something unless it's really cheap. To get something to go before the investment committee, it has to feel like a distressed debt deal,” said the European executive.
Green Street property analysts have compiled a list of more than €3.3 billion worth of office buildings in the UK and Europe that were put on the market in 2023 but did not sell, including Frankfurt's Commerzbank Tower, and said the list was probably just “the tip of the iceberg of aborted sales”.
The reality hits the market when loan repayments come due or loan terms are breached, forcing owners to try to negotiate careful deals with lenders or sell parts of the property privately to raise cash, a process that can be lengthy.
“People talk about refinancing walls, but in practice it never works that way. It's going to be years before those discussions pan out,” Knapp said.
The trouble with refinancing
The economic pain has not been evenly felt across the property market. For some landlords desperate for cash, the proliferation of alternative lenders since 2009 means there are debt funds ready to make up for what banks have left behind.
“Suddenly in the last 12 months, everyone seems to have realised that I don't have to buy the asset at 100% of the price, I can lend against it at 60%. If it all goes wrong, I have senior security,” said Lisa Attenborough, head of debt advisory at Knight Frank. “I probably have over 100 credit funds on my books now.”
With the possibility of further declines in property prices making simple purchases seem daunting at times, new investors are flocking to credit, with many seeing debt as a safer investment.
“It's hard to price assets at extended highs, so it's equally hard to find buyers willing to take on equity risk,” said Max von Herter, European head of M&A at real estate investment bank Eastdil Secured. “It's easier to trade on margin. Investors can make substantial gains without risking their first dollar.”
But financing is not available to everyone.
Cigna has a 1.3 billion euro loan due in 2023 and is struggling to meet it despite frantic negotiations with lenders and potential new investors.
Assets with good rental prospects, such as warehouses, residential properties and top floor offices, will be easier to refinance.
The difference is between an asset that you need to ensure is reasonably valued, and an asset that is expected to lose value.
“The reality is that assets are stranding at a rate we've never seen before in the market,” said Raimondo Amabile, co-chief executive officer of PGIM's $210 billion real estate business. “Nobody wants to lend against stranded assets.”
Amabile said the calculus for office owners who may be left behind is “completely different.” “I'm not going to put a dime on this. Basically, the banks [problem],” He said.
Some assets will struggle because they have too much low-interest debt that needs to be refinanced, even if tenant demand and rents are decent.
Even big investors are cutting losses on some office buildings, including Brookfield's decision this year to default on two buildings in Los Angeles, and New York office buildings are being sold for less than the land they're worth as investors look for alternative uses for aging buildings.
The crisis facing North American office owners in particular – a sharp decline in demand, the need to spend heavily to renovate outdated buildings, combined with a sluggish real estate market and rising debt costs – amounts to “a mini global financial crisis for secondary office,” Knapp said.
Troubles in Europe
The storm is also raging in Germany, where Cigna's troubles will deal a further blow to the market and further discourage banks from lending to commercial real estate.
“There will be some fire selling, but it's not going to break the banks,” said Peter Papadakos, head of European research at Green Street. “Cigna is not going to affect the whole property market. The real disruption will be in Germany in particular, and in offices.”
Still, a drop in inflation in October and growing market confidence that interest rates will be cut sooner than previously thought have stoked private hopes that some in the real estate industry can weather the downturn. European property stocks have risen almost 25% since the end of October as investors adjust their expectations.
Real estate veterans say the industry has functioned with high interest rates for decades. The challenge for an asset class that relies heavily on debt is navigating the change after more than a decade of borrowing at ultra-low interest rates.
“It's going to take some time for people to calm down from the excitement of the low interest rate environment,” said Philip Moore, head of European real estate debt at Ares. “The fact that the low interest rate environment of the last decade has been more temporary than normal is gradually becoming clear.”