28 Feb 2023
In the aftermath of the Global Financial Crisis, borrowers and banks enjoyed a period of lower interest rates which created an abundance of confidence in accumulating assets as the cost of debt was favorable to the borrower. Today, however, in a post-pandemic world, inflation has risen remarkably. As a result, central bankers have initiated a series of rising interest rate hikes that have shifted both fixed income and equity markets as investors seek to adjust to a higher cost of debt. Increased rates have translated into much higher borrowing costs and mortgage rates for real estate investors. Questions remain about what these volatile conditions will mean for real estate portfolios over the year in 2023.
On a positive note, banks have successfully de-leveraged over time to reduce the number of NPLs, with the exception of UTP loans that will likely come to surface as mild recessionary conditions appear across the European continent. Banks today, however, are better positioned to weather NPLs owing to higher supervisory standards, than they were in the Global Financial Crisis.
Markets are yet to see the full impact of slowdown conditions as DAVOS has advised of a less severe recession compared with contemporary opinions and other reports. The rise in interest rates is slowing down the signing of mortgages and consequently is affecting the real estate sector as well as creating recessionary conditions. Real estate has been a driver of economic recovery post-pandemic, and the consequences of a slower real estate market are yet to be fully realized, experts claim.
Otherwise, uncertainty about debt pricing makes it more difficult to underwrite loans in the current environment as real estate valuations and liquidity are now subject to numerous forces that include volatility created by geopolitical tensions, oil price fluctuations, and threats of increased war. Together, new patterns in work and investor appetite shifting away from office properties act to create downward pressure on ownership and investment in commercial real estate.
Overall, sources indicate an increase in NPLs – the Italian Bank, Banca IFIS has indicated that for the three-year period 2022-2024, €82 billion of new non-performing loans are estimated, while a peak is likely to occur in 2023 (Banca IFIS forecast report). As pressure increases for real estate markets, expectations include a higher level of NPL transactions and UTP exposures that will be sold. An increase in the sale of foreclosed assets is also expected. NPLs: Early signs point towards an increase in 2023 – KPMG Global (home.kpmg)
While a huge increase in NPLs is not likely, we expect overall to experience a lower number of transactions in real estate. Higher interest rates translate into higher mortgage loan costs, making it more expensive for buyers. That results in reduced demand for home purchases and loans. Sellers will be impacted as a reduction in price will be needed to attract buyers, especially in a slower and slightly recessionary environment. This emphasizes that the portfolio owner will need to prioritize vigilance in determining the best time to sell as the capital and opportunity cost is much higher in a rising interest rate environment and underscores the importance of liquidity.
