Real Estate Report: Increased Rates have Translated into Higher Debt Costs that have Moderated Achievable Returns in Property Markets

Six months into 2023, private real estate was still “weathering ongoing macroeconomic headwinds,” according to an update shared by Pitchbook.

In the US, the federal funds rate “has steadily increased since March 2022, hovering
within a range of 5.0% and 5.25% as of the end of June 2023,” the Pitchbook report noted.

As stated in the update, US annual inflation has reportedly “been on a downward trajectory in the past several months, reaching 3.0% in June, but trended back upward to 3.7% in August, remaining well above the Federal Reserve’s 2.0% target.”

Following a similar trend, the European Central Bank and the Bank of England implemented hikes “up to 4.0% and 5.25%, respectively, in September as the two institutions also aim to curb inflation across the continent.”

These increased rates “have translated into higher debt costs that have moderated the achievable returns in real estate— an asset class that relies heavily on leverage,” the report from Pitchbook revealed.

As noted in the report, constraining the usage of leverage available for real estate “even further is the continued tightening of credit conditions at major US banks, exacerbated by the March 2023 banking crisis that generated renewed attention to regional banks’ potential exposure to commercial real estate.”

However, it is “not all bad news—many industry experts believe that the US will likely avoid a severe recession and undergo a soft-landing scenario, which comes as a relief to investors.”

Meanwhile, the big real estate story out of Asia is “the trouble brewing in the Chinese real estate market.” Pitchbook further noted that Country Garden, one of China’s largest remaining property developers, and Zhongrong International Trust—a shadow-banking entity that both lends and invests in Chinese real estate, stocks, bonds, and other commodities—defaulted on interest payments of $22.5 million and $19.0 million, respectively, in August 2023.”

Spurred by a 33.1% YoY decline in home sales “as of the end of July, Chinese real estate developers are finding themselves severely cash constrained and unable to service their debts.”

There is also increased scrutiny “into China’s trust companies, which are estimated to have $2.9 trillion in assets under management.”

With 70% of China’s household wealth “derived from real estate, falling home prices and potential defaults of entities with massive influence in the property sector is putting incredible pressure on the Chines up.”

Currently, the fate of Zhongrong International Trust’s “outstanding payments is still unknown. Because real estate markets tend to be localized, it is unclear how much of an effect these events will have on global real estate.”

For instance, Evergrande, which “filed for bankruptcy in the US in August 2023 after defaulting on a loan of $300 billion in 2021, did not derail real estate investments throughout the rest of the world.”

According to a poll conducted by Bank of America in September 2023, fund managers were “asked what factor might cause a ‘systemic credit event’; one-third of fund managers who responded to the poll pointed to Chinese real estate.”

These mixed global signals “underlie private real estate’s muted fundraising data through Q2 2023. So far this year, $66.8 billion has been raised by 87 funds, which represents much less than half of 2022’s annual figures of $159.5 billion across 476 funds.”

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