Is the real estate industry threatened by a new 2007?! - What impact will war, inflation and rising interest rates have?

In the face of inflation, the Ukraine war and fears of recession, the financial markets are more fragile than they have been for a long time. Some economists see dangerous similarities to the financial crisis of 2007, and financial market expert Kenneth Rogoff even speaks of a "perfect storm" that is brewing.

The close links between the real estate industry and the financial markets mean that more and more real estate players are now keeping a wary eye on what is happening in the financial sector. High construction costs, rising loans and cautious investment markets are just some of the most important effects that another crash could cause.

But what exactly do real estate companies need to prepare for should such a scenario occur?

We have summarized the five most likely effects for you:

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1) High inflation leads to high interest rates

Everyone is feeling the effects of rising inflation. To counteract this, the FED and ECB began raising key interest rates in the middle of the year. This in turn has a direct impact on the real estate industry: Higher interest rates have made financing costs massively more expensive. Borrowing costs almost tripled during the first three months of the interest rate hike. And even if initial voices from central bank circles are suggesting that the rise in interest rates will only be very moderate in the course of the year, the impact on the sector should not be underestimated. As a result of the restraint shown by established lenders, some market experts are even assuming that there will be a measurable impact on real estate prices and thus on the supply/demand ratio.

The first effects are already being felt, especially in the residential segment. More and more people can no longer afford to buy a property and have to switch to rental apartments. As a result, higher-income apartment seekers in particular are entering the market, which is likely to drive demand for high-quality housing in the short to medium term.

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2) Inflation only one of the drivers of housing costs

In addition to everyday consumer goods, inflation naturally also drives up rents. Index-linked rents are particularly affected here, as they are not tied to the local rent index and are linked to inflation. These leases are particularly popular in metropolitan areas - the Hamburg Tenants' Association estimates that up to 50 percent of newly concluded leases in the Hanseatic city are index-linked. This additional burden hits households with a low income particularly hard.

In addition to inflation, rising energy prices are becoming a particular problem. In some places, they have risen by more than 35 percent since May of this year compared with the same month last year. The financial pressure on those who have to spend a large part of their income on precisely these energy costs and who have hardly any reserves anyway is thus becoming ever greater. If one believes the owner federation house & reason, additional cost loads of over 80 per cent could come on the households. After two years of the Corona pandemic and little economic recovery, this could cause massive difficulties.

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3) Energy costs become a problem for unrenovated properties

It is not only private households that will face major problems in the medium term as a result of energy costs. Their increase will also have an impact on the valuation of real estate. If ESG-compliant buildings can benefit significantly from this, it will be the old, unrenovated properties in particular that will have to reckon with devaluation as a result of rising prices. As a result, rents will probably be much more closely linked to age and the level of modernization in the future.

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4) Investment markets stand still

A clear indicator of a crisis is usually the activity on the investment market. If the risks increase, the caution of the more conservative investors also grows. In May 2022, for example, the real estate services company Savills registered a massive decline in investments in both residential and commercial real estate. This is a development that has not been measured for ten years.

The reason for this is likely to be the increased financing costs. Investors will have to recalculate their financing plans and act much more sparingly and risk-consciously. Institutional investors in particular will probably prefer safe investment opportunities in the medium term - a behavior that has already been observed in other crises.

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5) The material becomes scarce

Discussions about interest rates and energy prices are justifiably in the spotlight at the moment, but all the associated problems fade into the background when there is a shortage of material on construction sites. A not inconsiderable proportion of the reinforcing steel used in Germany has so far come from Ukraine, Belarus and Russia. Since the beginning of the war, this material has been missing, which has reportedly led to the first construction stops.

In addition, high energy prices are making production uneconomical. Price increases of up to 17 percent mean that projects are becoming increasingly difficult to calculate. In the worst case, they have even had to be cancelled altogether.

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Conclusion

War, inflation, rising interest rates, lack of materials - the list of current challenges is long. At the same time, the real estate industry must adapt to megatrends such as digitization, sustainability and demographic change.

All these factors will ensure that investment decisions in the future will once again focus on fundamental factors: location, demographic dynamics or building quality could be the deciding factor in the profitability of a project in the medium term.

The industry must adapt to the new realities, and ESG-compliant projects in particular can represent promising investment opportunities.

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