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'A Whiff Of 2007' As Cracks Show In CRE Investment

Collapsed sales, a dwindling pool of buyers, the increasing price of debt — a growing pool of evidence points to a significant slowdown in U.S., UK and European real estate investment markets in the second half of 2022 and beyond, and it may be accompanied by a fall in values in most sectors.


“We are seeing a softening of yields in several sectors combined with a number of counterparties seeking a reduction in purchase prices,” Clearbell Capital Senior Partner Manish Chande told Bisnow

Pulling together the threads from different regions paints a picture of a market that will be significantly affected by an end of cheap money and a rise in prices for consumers and corporate occupiers. 

For the last decade, real estate pricing has benefitted greatly from the rule of TINA. But her benevolent reign is over. 

“With U.S. and EU rates back to levels not seen in a decade at 3% and 2%, investors now have alternatives outside of real estate (and equity), in contrast to the TINA (there is no alternative) situation of recent years with negative rates,” Bank of America wrote in a note on European office real estate stocks recently. 

As interest rates and bond yields rise, there are more alternatives to real estate where investors can put money in secure assets that provide income. 

The average cost of debt for office real estate in Europe is 4.8%, Bank of America said, the highest since 2007. This is higher than the average yield in most big European cities, meaning you pay out more in interest than you earn in rent. That situation is viable if you can expect rents to grow, but given the potential for economic stagflation and the drop in demand for all but the best offices, that is far from a given. 

The increased cost of borrowing will also hit the logistics and multifamily sectors, where yields are even lower. But those sectors are seeing rental growth, so the issue is less acute.

“After 10 years of steady yield compression, prime office properties are today reaching historical lows between 3% and 3.5%, significantly below current costs of borrowing at 4.5%,” Bank of America said. 

In the U.S., the Federal Reserve has raised rates even more quickly, so the same situation is emerging, albeit yields (cap rates) are higher in the U.S., so there is more room for rates to rise before the amount paid in interest exceeds the amount earned in rent.

Lenders reacted in May to the increase in rates and market uncertainty in the U.S. by decreasing the loan-to-value ratio at which they will lend, MSCI data showed. 

That reduces the number of buyers in the market, as those who borrow to invest are less competitive, and can’t bid at as high a price as before. Bank of America predicted that European office real estate prices will drop 12% by the end of 2024, and Green Street said the price of its U.S. commercial real estate index has dropped 5% since the end of March. 

MSCI data highlights how headline figures about investment volumes in both the U.S. and UK hide an underlying fragility in both markets.

In the U.S., while the number of deals grew from May 2021 to May 2022, the number of investors shrank — a smaller number of investors is undertaking a bigger number of deals, indicating that the market of buyers is not as deep.

Prices are still growing, MSCI found, but that growth is decelerating.

“No one wants to buy at the top of the market,” it said. 

In the UK, while the volume of the deals completed in the first five months of 2022 grew compared to 2021, the number of deals shrank, and it was well below the 10-year average. Again, the market has become concentrated in a smaller number of larger deals. 

MSCI reported that on a global basis the number of buyers actively seeking real estate assets more than halved between the fourth quarter of last year and the second quarter of this year, to just 1,602. The number of UK deals under contract has fallen from €17B in March 2021 to €12B in March this year. 

And the theory is starting to play out in reality, with deals in major markets across the globe starting to fall apart. 

In London, the £720M sale by Norges Bank Investment Management of Bank of America’s London HQ, and the £3B sale of Lone Star’s Wembley Park build-to-rent scheme have both stalled because of market uncertainty, React News reported. 

React also reported on the sale of a €500M office asset in Berlin hitting the skids. Berlin, with its booming tech scene but prices lower than other large German cities, has been a real estate hot spot for the past five years. 

In New York, market sources indicated that Innovo Property Group’s attempt to buy HSBC Tower at 452 Fifth Ave. went south because of interest rates. The $855M deal fell apart last month after Innovo was unable to lock down financing.

Even the powerhouse industrial sector is not immune to blips. Earlier this month, CoStar reported that Ares needed to cut the asking price on a Spanish portfolio it was selling by €20M to €100M. 

“2022 has a whiff of 2007 about it, with ‘cracks all around’ (Chinese property, credit stress, consumer squeeze and leverage still at 14x EBITDA in line with 2007), and direct investors being ‘aware of the challenges ahead’ but preferring to rely on the abundant liquidity and dry powder (still?) available in real estate, another parallel with 2007,” Bank of America said.