So far, the german real estate markets have come through the turbulence of recent years comparatively unscathed. Transaction volumes increased significantly in 2011 and office vacancy rates fell slightly. Is this development now coming to an end because a refinancing crisis for real estate loans is looming in the wake of the sovereign debt crisis? Commercial real estate loans in europe will have to be extended in the triple-digit billions over the next few years. This could prove to be a herculean task for the financial sector in view of regulatory tightening.
Macroeconomic general weather situation: bright to cloudy
In 2011, the volume of commercial real estate investments in germany rose by more than 20 percent to just under 24 billion euros. Office vacancies were also reduced somewhat in 2011 and office rents in the main office cities increased slightly. In addition, the german labor market is proving to be surprisingly robust in the face of the uncertainties that have spread like a paralyzing fog across all european economies in recent months in the wake of the sovereign debt crisis in europe. Recently, even important leading indicators such as the ifo business climate index for the overall economy have improved. The german hypo real estate climate index has also ended its downward slide in recent months and is now back near the high levels seen in summer 2011. Of course, many of these improvements in the real estate markets are initially a reflection of the crisis levels from 2008 and 2009. However, it is even more important to mention that these positive developments of the last quarters cannot simply be extrapolated into the future.
Consolidation pressure in many european countries will only allow homeopathic growth in the euro zone in 2012, according to current OECD forecasts. Economic growth of less than one percent is expected for germany, and even recession for greece, portugal and italy. Further decline in vacancy rates on german office markets unlikely in view of such low economic momentum. But for the next few quarters, this is not the biggest challenge facing the german and european real estate industry. More seriously, a dangerous cocktail of the historical legacy of the last financing boom (2003 to 2007), a tightening of the regulatory environment for real estate financing and, finally, the still incomplete clean-up of open-ended real estate funds will form for real estate financing and, derived from this, for the real estate investment markets.
Refinancing pressure on the rise
In total, the volume of commercial real estate loans from banks in germany amounts to around 500 billion euros. For europe as a whole, this figure is around 2.500 billion euros. These huge figures in themselves are unproblematic, because in relation to gross domestic product they primarily reflect the importance of the real estate industry. Nevertheless, these figures conceal three problem areas:
First, a large proportion of commercial real estate loans were taken out in the gold-rush years before the financial crisis and a large proportion are due for renewal in the next five years.
Second, prior to the financial crisis, the securitization segment of the market in particular was growing strongly; for europe, it accounts for only about 10 percent of the total commercial real estate loan portfolio, but since the securitization market has still not regained its footing and very often real estate loans were securitized that would not have been eligible for pfandbrief, it is these maturing securitizations that carry risks. This is also true because investors have very different interests in the individual tranches of securitization. If one wants to spread investor risks, the atomistic structure of investors is basically an advantage, but it can prove to be a problem when negotiating an extension.
For europe as a whole, 20 to 25 billion euros of commercial mortgage-backed securities (CMBS) will mature each year from 2013 to 2019. This is equivalent to the total commercial real estate transaction volume of an average year in germany. It is not a quantite negligeable – and normal commercial real estate loans are explicitly not included here yet. These traditional loans are easier to extend than CMBS, but in view of the changes in the regulatory framework, tough negotiations with the banks are also looming here.
Third, the statistics regarding the maturity structure of commercial real estate loans or CMBS are completely unsatisfactory; thus, depending on the data source, one gets not only a different structure, but even a different total volume. The real estate industry is like a ship that needs to prepare for heavy seas, but does not know how high the waves will get or when they might arrive. In such uncertain situations, experienced captains will moor more than is necessary.
Safe is safe. The ocean-going mariners' association, in this case the representatives of the real estate industry, should therefore definitely push for more reliable and granular data for commercial real estate loans, because this is the only way to design appropriate crisis strategies.
Additional stress factors
The financing problem will be exacerbated in the coming years by a number of regulatory measures, in particular the stricter equity and liquidity requirements imposed on the financial sector by basel III. These tightening measures are a legacy of the debt boom up to 2007. They are understandable in the long term macroeconomically, because they will help reduce fluctuations in real estate and macroeconomic cycles. In the short term, however, these measures will make access to debt more difficult, and not just for real estate investors. The risk of distress sales, as well as the number of tactical property sales to raise liquidity, will thus increase in the coming years – notwithstanding the semantic tightrope acts to avoid the term "distress sale".
In addition to this direct burden on the real estate sector from basel III, there is a second negative factor that has rarely been addressed to date: basel III not only narrows the debt channel for real estate financing, but also reduces the expansion opportunities of capital-intensive industries; this fact in turn limits the leasing potential for the real estate industry. Industrial and logistics properties are more affected by this than office or even residential properties. To remain in the image of shipping: basel III acts like two enormous concrete walls that will channel the swell through a narrowed channel, causing refinancing waves to pile up even higher than they already are.
Finally, some open-ended real estate funds, the supertankers of the real estate industry of earlier decades, so to speak, have still not been able to satisfactorily plug their liquidity leaks. Neither the overall economic environment nor the financing situation allows time to compensate for the undesirable developments of recent years through growth processes, so that further forced sales are threatening from this side as well. In this light, it would be appropriate in the future not to celebrate every increase in transaction volume as cheering news for the real estate industry.
More equity in real estate financing
The financial and economic crisis marked a turning point for the global real estate industry. The leverage-induced boom has ended, and even if it were indeed possible to get the securitization market up and running again, future securitizations would be much more cautiously priced and much less able to bet on risky assets than before the financial crisis. Overall, the securitization market will no longer reach the level of the pre-crisis years. Sometimes looking forward from the securitization market "2.0" spoken – with regard to the expected securitization volume, "0 would probably be.2" the more appropriate target. Just as the sovereign debt crisis in europe has led to a renewed emphasis on differentiating the risks of individual debtor countries, so too will individual real estate risks be analyzed more closely and priced more accurately in the future. If greater attention is once again paid to maturity matching and location valuation, this is not a bad development for the real estate industry in the long run. For the next few years, however, real estate market players should be aware that not all the turbulence is over yet.
This is by no means bad news for all players either, because ultimately the transition to more equity in the real estate industry means a structural change, at the end of which sovereign wealth funds, private equity companies, insurance companies and perhaps even reits could play a bigger role than they do today. In this respect, the term structural change is also better than the frequently used image of a tsunami. This would mean that only devastation would be left afterwards – this is highly exaggerated with all the concern about the developments.