Rising debt costs chill global real estate outlook
As the cost of debt nudges higher than potential yield, real estate investors are re-evaluating their exposure to the sector.
Global real estate investors entered the year in buoyant mood. Many property sectors racked up bumper returns in 2021. Globally, self-storage and industrial assets, for example, achieved total returns of 77.5% and 50.9% respectively, according to the National Association of Real Estate Investment Trusts (Nareit). Investment activity continued in a similar vein into this year, with global volumes 13% higher in the first six months of 2022 compared with the same period in 2021, Savills data shows.
But with central banks around the world beginning to raise interest rates to tackle surging inflation, real estate investors who had grown accustomed to cheap borrowing are now facing the prospect of far costlier loans, in some cases at rates that were higher than the yields available in the underlying real estate assets.
“When swap rates were lower, the typical all-in debt costs for most European markets were around 100 basis points, which meant leveraged investors could still buy real estate assets even at yields of around 2.5% to 3%,” says Craig Wright, head of European real estate investment research at Abrdn.
“At that level, you can still make your return targets, but with the cost of debt going up roughly 200bp, that means the cost of debt in many cases is in excess of the yield that you’d get on the asset; therefore debt is not adding to performance anymore.”