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LOOK AHEAD 2019: Rising rates and more debt for development

The ‘new normal’ level of interest rates will be lower than many expect, forecasts Paul Coates, executive director and head of debt and structured finance EMEA at CBRE.

Interest rates, development finance, hedging costs and margin compression will be among the factors at work in European real estate finance markets in 2019, Paul Coates, CBRE’s executive director and head of debt and structured finance EMEA, tells Real Estate Capital.

Below are his predictions for the coming year (including his sporting tips):

Rising interest rates: Interest rates are expected to drift upwards in 2019, adding to the total cost of debt. This is a concern on the asset pricing side as well as from the debt affordability perspective, given the relationship between interest rates and property yields. Investor concern may be overblown in the longer term, however; at CBRE we believe that changing demographic trends will mean the new ‘normal’ level of interest rates is likely to be much lower than the consensus of economic forecasters, and well below pre-2008 levels.

• Increasing development finance: We have seen greater appetite for lending to commercial real estate throughout the year but there is a renewed enthusiasm for financing asset repositioning and full-on speculative development, albeit on a selective basis. Some lenders, on seeing a less thoroughly provided-for area of the market, are taking the opportunity to secure enhanced returns while being careful to choose schemes that meet their view of sustainable assets in sustainable locations backed by strong sponsors. We expect this prudent outlook to deal-making to continue into 2019, but we expect to see continued appetite to facilitate speculative development as lenders find opportunities to fill the lending gap.

• Hedging: Overseas investors are aided by the attractive boost to returns when hedging domestic currency against sterling and the euro, given the lower interest rate environment than in the US and many Asian countries. As such, we are expecting US capital in particular to invest in UK and European real estate debt to take advantage of the favourable differential, where the carry-on offer can greatly enhance nominal returns. It should also be recognised that this form of exposure to real estate is attractive in its own right on a risk-adjusted basis. In the UK, for example, ungeared total returns from direct ownership of real estate are not forecast to be above 3 percent per year over the next five years, making the 2.8 percent per year return available from senior lending (55 percent loan-to-value) to prime London offices very compelling, given the additional protection against downside risks it offers.

• Further margin compression in the rest of Western Europe: Over the first three quarters of the year we saw significant margin compression in the group of Western European markets excluding France, Germany, Italy and the UK – where margins were generally more stable. In Q3 2018 it was Ireland and Spain that saw significant falls but in preceding quarters markets such as Austria, Belgium, the Netherlands, Portugal and Switzerland had also seen declines. Looking ahead to 2019, we expect margin compression to continue, albeit not to the same degree, as the market becomes increasingly competitive.

• The following teams will win their domestic leagues: Liverpool, Dortmund, Paris St Germain, Juventus, Barcelona. In cricket, England will win the Ashes and the World Cup, while Ireland will win the Rugby World Cup.

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