The market is a long hurdle race: The question is how many hurdles need to be cleared?
Carsten Tirsbæk has been employed at BRFkredit/Jyske Realkredit since 1990, accumulating over 30 years of experience in the financial sector at large, with a specific focus on the Danish mortgage credit market. He has been operating at the executive level since 2001. Regarding the current commercial real estate market, he rhetorically inquires “What market?” and elaborates:
”Not much has been happening, to be honest. Over the past 1 ½ years, the significant rise in interest rates has significantly dampened the situation. These interest rate increases have raised the required rate of return. However, we have also witnessed escalator clauses and vacancy rates aren’t challenging for most segments. At the moment, sellers and buyers are simply too far apart. Overall, this means that sellers have reasonable financials and liquidity, so they aren’t willing to compromise on prices. This means it will likely continue to see a fair bit of “tug-of-war.” Currently the market is like navigating through a lengthy hurdle race, and the question is how many hurdles investors can keep jumping over before more start stumbling over them.”
”The Danish economy is in a strong position compared to Europe. Both businesses and individuals are relatively well-off financially. We are in significantly better shape than after the financial crises, as more capital has been built up, and the loan-to-value ratio (LTV) generally is lower. Compared to the past, there is a substantial amount of money in the market from both Danish and international investors, so many are ready to invest when the timing is deemed suitable. So, when is the right time? What uncertainties exist? What is the most likely outcome among the many scenarios?”
Timing for Investment
Timing often plays a crucial part in determining how good a trade or investment is. “Notably, when it comes to real estate, the interest rate level is a significant factor. Most economists agree that interest rates have peaked, and we will begin to see a decline in 2024. Some will argue the start of 2024, and some will argue the end of 2024. We found ourselves somewhere in the middle, where at Jyske Realkredit, we anticipate that interest rates will start moving downward again during the summer of 2024. Perhaps this will also contribute to give the market a little more momentum? Property prices will also impact property taxes. Currently, there is a lot of debate about preliminary property valuations. We will also see some uncertainty when it’s time for commercial properties, especially because the reference point for valuing the land is what we already know, which has posed some challenges for residential properties. In this game, there will be both winners and losers, but perhaps, worst of all, a period of uncertainty.”
Not cheaper to borrow money
The mortgage institutions in Denmark play a central role in the Danish economy. They specialize in providing financing against security in property collateral. Regarding issuers’ ability to meet obligations to investors, the Danish mortgage credit system is among the safest in the world. Carsten Tirsbæk states:
“The Systematic Risk Council has just issued a recommendation that a sector-specific systematic buffer for exposures to property companies be activated in the commercial real estate sector, with a rate of 7% of risk-weighted assets, effective from June 30, 2024. The argument is that the currently higher interest rates contribute to increased costs in the industry, which raise the risk of loan losses, and that the financial institutions’ risk models do not account for this. In practice, this translates to increased capital requirements for various banks and mortgage credit institutions of 30-60% on these properties.”
It’s no secret that we think it’s gone far beyond the mark. Let me clarify: this will not contribute to cheaper borrowing. In general, customers should get used to the fact that they need to bring more money when they want to borrow. Banks and mortgage institutions have just received new guidelines from the Financial Supervisory Authority, with 120 points we must adhere to regarding due diligence and the project/property being considered for financing. Then there’s the liquidity rule, which means there must be positive liquidity in the property, including financing costs, for a fixed-rate loan with amortization. With the current interest rate level, an 80% loan-to-value ratio for a residential rental property is a distant dream. It’s more likely to be somewhere between 60-70% that can be leveraged. So YES, more money needs to come from the customer’s side.
” We are experiencing intense competition in the loan market, both among mortgage institutions and banks. At the moment, one could arguably say that supply exceeds demand. Recent years regulations and the pipeline in the field are likely to reduce the variance between the terms offered by different providers. So, even though it becomes harder to differentiate oneself in the market, the supply-demand dimension will still operate. It is, of course, good for competition that many of us are willing to lend to the right customers and property transactions.”
Attention: Get a Grip on ESG
ESG is yet another dark horse in the real estate market. Carsten Tirsbæk says:” We make a living by lending money to customers we believe will be able to pay us back. We must be confident that customers can repay us before entering a partnership. The better we know the customers can document their business, the better our ability to make the right lending decisions, which ultimately means fewer losses. A new dimension in customer analysis, and increasingly crucial for lending decisions in the future, is ESG. Here, we have a clear call to our customers: Start documenting your efforts and results as soon as possible. It will make a significant difference so those customers who are prepared and have done their homework will be in a much stronger position, not only to borrow money and do business but also to take advantage of the opportunities that will undoubtedly arise in the real estate market.
“The influential political pressure, which is already a reality, will result in massive regulation in the coming years. For example, negotiations in the EU are currently underway concerning building directives that will set the framework for how much one will be obligated to invest in energy improvements in their properties. What are the company’s ambitions in the ESG area? What is the property strategy? What do the data show about consumption and CO2 emissions? How can you improve? What is the plan for improvement?” Our call to companies is to work ambitiously on ESG, create transparency, and provide documentation. There are all sorts of scenarios in play, and it’s hard to predict how it will end. But one thing is sure: Get control of ESG data, or you’ll be at the back of the platform when the ESG train departs. There will undoubtedly be many requirements, which will come quite forcefully.
Liquidity and Optimism
Carsten Tirsbæk concludes: “Despite uncertainties and dark horses, we are not running around being overly pessimistic. In general, our customers are doing well. Liquidity is still reasonable for the vast majority of customers even with the rising interest rates. So, there aren’t any serious issues. The installments are being paid as they should. We were worried that it would look worse. In the future it’s naïve to think that everyone can sail through without challenges. But in my opinion, we are not facing a major crisis. Returning to the hurdle race, there will always be some with heavy legs who stumble over a hurdle, but the vast majority have prepared themselves so well they will clear the hurdles as they should.