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Thursday
February 2023
The 5-year interest rate increased by about 3% in 2022. I am sitting at this writing looking at the long-term curve of the 5-year capital market (IRS). In 2016, the 5-year interest rate reached about 0% while the position is now about 3%. So from 2016 to 2021 we have already gotten used to those low interest rates for 6 years! We have become spoiled!
Low interest rates over?
Personally, I think this is a favorable development. The positive effect on pension funds’ funding levels alone is worth welcoming this level of interest rates. Virtually free money is over. Is that 3% so extremely high now? No that’s not so bad. But from the borrower’s perspective, much has changed. New construction projects are no longer starting up due to increased interest rates combined with increased construction costs. Despite the housing shortage, this has put sand in the engine for new home sales. I wonder who can or will absorb this renewed reality.
Real estate refinancings
In our field of debt structuring, I would venture to say that refinancing real estate is going to result in substantially higher interest costs that no longer match the current rental rate or the disappointing appreciation in the project. Corrections to the value of both commercial and residential properties are now visible. The price of owner-occupied housing is actually cooling despite housing shortages. A strong negative scenario would be if property owners are forced by financiers to make additional repayments or sell part of their property portfolio due to higher interest rates in combination with declines in value and thus higher LTVs in their loan portfolios. That this arises from time to time the market can absorb, but if too many parties have to do this at the same time you get a compounding effect on the decline in property values.
High inflation rates
Whether it will go that far? I don’t think so. Real estate shortages and gradualism are the dampeners of these effects here. But everyone in the market involved in real estate, such as homeowners, real estate investors, developers, construction companies, self-employed construction workers, etc., etc., are going to feel the negative effects. High inflation rates mean that central banks cannot adjust for these negative effects, even though this would be desirable from a cyclical perspective. A period of healthy correction in the real estate sector separating the wheat from the chaff is coming.
So dear real estate entrepreneurs: keep watching the market, as there will eventually be gems passing by in that correction period! And we continue to do what we’ve always done in our financing analysis: Focus on healthy cash flow!