M&G, an investment manager, recently published a report on the risks to the global real estate market and their sources. The conclusions of the company’s research were unequivocal: the market is rebalancing, but the storm has not passed yet. Among the main market impediments and risk factors, M&G cites tighter lending conditions in addition to higher interest rates, instability in the banking system as a whole, a number of structural changes in the construction sector, including the need to bet heavily on ESG standards, and the prevalence of a hybrid work model.
M&G adds that the global real estate market is facing “a prolonged period of tighter credit conditions as banks and other lenders adopt stricter financial controls” on who should be given what funds. This will lead to a scenario that will “hamper capital value growth and recovery,” especially in those market segments “with significant exposure to weaker or riskier assets and over-leveraged investors who now face refinancing risks.”
The situation in the United States is specially mentioned, where one of the main problems is the “continued disproportionate lending by mid-sized banks to owners and property developers,” which is “putting significant stress on the banking sector.” According to M&G, almost 30% of all loans issued by US regional banks are to commercial real estate borrowers. This is much higher than the figures observed in the UK and the EU (about 5%). That said, commercial real estate in the United States is in a particularly vulnerable position today.
However, the report notes that at the moment, real estate investors, especially those who are over-leveraged, still act with caution and take into consideration the uncertainty in the market. A rather small percentage of people prefer to deal with risky assets. Otherwise, they demand greater compensation for taking greater risk. According to M&G, this has led to investors shifting towards “prime assets with secure cashflows.” The vacancy of less stable assets is growing, including offices and retail real estate.
M&G also stresses that due to the lower availability of loan capital and high risks of loss, the volume of investments in “non-prime” assets will be reduced, which will affect the drop in their value. This creates a certain circle when a risky asset will lose value due to its riskiness, which will repel even more people from investing in it and lead to even greater loss of value. The same situation applies, for example, to the compliance of properties with environmental standards: if the property does not receive attention from investors due to non-compliance with standards, the owners will have less motivation to invest in renovation.