Sentiment among bank lenders and borrowers coloured by inflationary fears

Two of Germany's key sentiment indicators for the real estate industry are pointing in a downward direction, with industry professionals now bracing themselves for worsening financing conditions as well as sharply rising construction costs. The two, the ZIA-IW Real Estate Sentiment Index (ISI) and the BF.Quarterly Barometer, see rising caution by lenders amid gloomy sentiment.

A recent survey by the Institut der deutschen Wirtschaft (IW Köln) in co-operation with the industry's umbrella lobby group ZIA showed a deterioration in professionals' expectations over the first quarter - and that did not include all respondents' feedback, much of which was gathered before the Russian invasion of Ukraine.

Using the proprietary tools of its quarterly barometer, the ZIA-IW Real Estate Sentiment Index (ISI) fell by 1.6 points to 30.7 points in the first quarter. At a total value of 66.7 on its gauge, the overall outlook is not bad historically, but expectations have now actually turned negative for the first time since Q4 in 2019.

Of particular concern to the industry are the starkly rising costs, making themselves felt on many levels. While last year the building interest rate - the interest rate on a real estate loan with a ten-year fixed interest rate (the typically preferred choice in Germany, rather than a variable rate) was still at a record low, it has been rising rapidly as the market anticipates the European Central Bank raising their interest rates to combat inflation.

Both commercial builders and private individuals planning to build homes are looking at interest rates of between 1.5% and 1.6% for five- and ten-year loans, but these are already looking outdated, with 2.0% now looming on the horizon.

When asked at what interest rate level a turn in the trend of still-rising prices for homes could lead to a fall, respondents put that, on average, at 2.4%.

The study's author, Dr. Michael Voigtländer, said: "The study still shows that the majority of participants do not yet expect any tipping effects in the real estate market. However, in view of the current dynamic development of interest rates, such a scenario can at least no longer be ruled out - while an interest rate of two percent is quite conceivable".

Rising financing costs are not the only problem. Rising energy costs are now seen as a major hindrance to landlords' ability to raise 'cold' rents, as tenants - both private and commercial - are focused on their overall costs, including heating and energy.

For the survey, the IW contacted the managing directors and senior executives of about 1200 real estate companies, with just over 400 companies taking part on a regular basis.

Even before the Russian invasion of Ukraine, respondents to BF.direkt's Quarterly Barometer were already turning 'reticent' on lending, with the Stuttgart-based advisor's quarterly reading showing real estate debt providers scaling back their expections in the tailwind of the COVID-19 pandemic.

The latest BF.Quarterly reading showed that, although sentiment among the more than 110 German property lenders polled had improved slightly from the previous quarter, it remained in the negative range. The survey’s rolling score increased to -4.86 points in Q1 2021, from a Q4 sentiment score of -8.08 points.

This brightening in sentiment is attributable to a modestly improved assessment of financing conditions, according to the German advisor. However, only 13% of the survey’s respondents (+5.5 pp) rate these as more progressive.

Manuel Köppel, CFO at BF.direkt, said: "It seems to us as if the banks are continuing to display a rather reticent attitude. My impression is that financial institutes have scaled back their expectations and adjusted them to the pandemic situation, so we need to bear this muted outlook in mind when interpreting the latest poll returns.”

Despite lower overall expectations, almost half of respondents said they expect growth in new lending activity. In total, 46.7% of the debt providers polled saw signs of growth, increasing from a 19.7% in the previous quarter.

Bank risk aversion is waning

The report also found a softening in lenders’ risk aversion, reflected in the decreasing influence of banks’ risk departments on new lending deals. According to the survey, this influence went down from 29.6% in Q4 to around 13% in Q1 2021.

Still, lenders remain risk averse in certain property sectors, particularly with shopping centres and hotel development financing. Just 10.7% of the survey’s respondents would be willing to fund hotels, while 21.4% were prepared to finance shopping centres or any other physical retail assets.

Average margins have increased significantly since the onset of the pandemic crisis. Margins for standing properties average 146 basis points (150bps in Q4), while for property developments they stand at 231bps, practically unchanged from 234bps in Q4.

The report also noted that loan-to-values have fallen to 66% on average, a 0.7 percentage points decrease from the previous quarter.

Nonetheless, REFIRE will be paying close attention to the soundings taken by both these barometers, as inevitably the full effect of the Russian invasion of Ukraine can hardly be reflected in these (now partly outdated) figures, albeit they are the latest available.