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Central banks have been stoking interest rate cuts to fuel financial markets, but the fastest cycle of interest rate hikes in a generation is creating real-world tensions, and nowhere is this more evident than in the commercial real estate industry.
Rising interest rates have caused real estate valuations to plummet, and while interest rates in Europe may not have risen as sharply as in the U.S., they are sure to lead to more turmoil in the real estate sector this year.
What has improved is investor confidence: While still well below their peaks, stock prices in the listed real estate sector in New York and Europe have risen 20% since the beginning of November, while 15-year Treasury yields have fallen 70 basis points in each case. This may be overly optimistic, given that the liquidation of distressed owners is still in the early stages.
Office space remains a thorn in the side of the sector on both sides of the Atlantic. The enduring popularity of working from home has reduced space demand by around 15% to 20%. Office vacancy rates in major U.S. cities last year reached their highest level since the late 1970s. About 20% of space was unoccupied in the fourth quarter, according to Moody's.
The situation is much better in Europe: Vacancy rates in major cities averaged 6.9% in the third quarter of last year, according to Savills, well below the rates during the global financial crisis.
Still, problems abound. The collapse of Rene Benko's Cigna real estate empire illustrates the dangers of excessive leverage built up during an era of low interest rates.
Refinancing is the biggest challenge: listed European real estate companies need to finance around 10% of their €300 billion in outstanding debt with new borrowing each year. Add in the unlisted sector and refinancing needs jump to an estimated €200 billion per year.
Debt levels are looking tight in Scandinavia, with Germany's Aroundtown, Sweden's Kastellum, SBB and Pandox among some of the owners that research firm GreenStreet says will see rising leverage and financing needs this year or next.
A weak office fundamentals and low rent growth mean financing conditions have changed: Peter Papadakos, head of European research at Green Street, reckons office landlords may get back just 75 cents for every euro they borrow in 2020.
That shortfall will have to be filled by new stock or asset sales. Valuations for private property owners have fallen less sharply, perhaps about half as much as would be expected from estimates of the prices at which properties are actually being sold.
The rush for liquidity will only intensify how much further these prices have to fall.
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