Insolvencies are on the rise and the real estate industry will be harder hit than after the collapse of Lehman Brothers in 2008, according to Hanspeter Gondring, managing partner of the ADI Academy of Real Estate Management and head of the Real Estate Management course at the Baden-Württemberg Cooperative State University (DHBW).
Hanspeter Gondring
The economist is a former trainee at the Deutsche Bundesbank and vice president of the Rheinischer Sparkassen-und Giroverband (Rhineland Savings Banks and Giro Association). Talking to Immobilienbrief Stuttgart ‘s Frank Peter Unterreiner earlier this month, Gondring noted that the real estate industry will feel the effects for years to come as redundancies rise, predicting that 40% to 50% of project developers and builders could become insolvent within the next three years: ‘My forecast is based on the deteriorating macroeconomic environment of the real estate industry and the projections derived from it,’ he said. ‘Assuming that the cost of capital will rise by another 1 to 2 percentage points over the next 18 months, that core inflation will not fall below 5%, and that construction costs will continue to rise, albeit only slightly, the cash flow return on projects will gradually approach the zero mark. When I add in the cost of risk, I end up with a negative rate of return.’
As a result, architects and planners are turning more to existing real estate, according to Gondring: ‘I don't want to be understood as saying that there will be no more orders in the next few years but smaller rolls will be baked and business models will have to be adapted,’ he said. Subsequently, energy-efficient refurbishments, smaller-scale project developments in existing buildings and changes of use are likely to dominate going forward, as are medium-sized contracts.
Project developments that already have a speculative momentum are particularly at risk, he said: ‘In two years, the spook will be over. These companies are the classic candidates for insolvency if the phase lasts three or more years and then runs out of steam.’ In business administration, tied-up capital that is not used in the value creation process is referred to as inventory costs, which initially depress returns and ultimately become a liquidity problem. ‘To put it in a nutshell: The number of insolvencies will rise, as will the number of applications for insolvency in self-administration, in order to gain time and breathing space for refurbishment measures. Most of the time, however, this is just a game of time.’
‘Drastic slumps’ expected in 2024
However, unlike the last economic downturn in 2008/2009, Gondring does not believe that we can just wait this one out: ‘Companies are fighting back massively against this downward trend, and so drastic slumps are not to be expected until 2024, and with them the insolvencies,’ he said. ‘By the way, the prices of the real estate AGs and REITS are more or less in free fall. The capital market assesses the situation of the real estate industry just as I do and is already pricing in the risk.’
Interest rates will remain high for some years to come, he said: ‘We must be careful that Germany does not become the sick man of Europe,’ he stressed, noting that the risk of insolvency results more from the increasing need for write-downs. ‘If companies have a low equity base, they very quickly become over-indebted if the depreciation expense eats up their equity.’
Gondring expects interest rates to hover around today’s levels until 2028/2029, after which point they are expected to fall: ‘The central banks are expecting a second wave of inflation, which also prompted the Fed to raise its key interest rate a few days ago to 5.25%,’ he said. ‘The ECB will follow. My thinking is that while core inflation will fall again in the next few years, it will take two to three years for it to reach the 2% mark.’
He notes that central banks need time before they can lower the key interest rate to a lower level again, giving the following example: ‘If core inflation were 2% again in 2026 and the key interest rate were 5.5%, it would take two years for the key interest rate to reach 3% but only on condition that the key interest rate is lowered by at least 1 percentage point per year. In mathematical terms, that would mean 2028, but if the key interest rate were to rise to 6% or more, the time needed to lower it would be correspondingly longer. Central banks can only raise or lower the key interest rate slowly and in small steps, because otherwise the capital markets would derail.’
Challenges for lenders are immense; they will ‘absolutely avoid taking write-downs on their good equity’
For banks, particularly Germany’s regional Volksbanks and savings banks, the challenges are immense, given that they are juggling a myriad of problems at the same time, according to Gondring: ‘Firstly, they cannot freeze their lending business because banks earn money from loans; they would deprive themselves of the basis of their business. Secondly, the counterparty risk increases with every loan transaction, and with it the latent need for valuation allowances.’ In addition, they cannot raise lending rates to the extent that would theoretically be possible, because otherwise there would be no demand for loans, which would lead to a seepage of the business base. Moreover, this type of bank raises interest rates on deposits only very slowly and with a delay, which means that, compared with branchless banks, for example, it loses not only the deposits but also the entire customer. ‘A comparison of overnight deposit interest rates at Verivox shows that there is not a single regional branch bank in the Top 40. I think that speaks for itself,’ he said.
And even though institutional investors have real estate quotas for their investment portfolios, this will be not be much help to developers, Gondring said: ‘The real estate quotas were put in place to limit the volatility of the investment portfolio because real estate has been a safe bank for the past decade or more. Institutional investors will also adjust the ratios downward based on new correlation calculations because they will absolutely avoid taking write-downs on their good equity, which they need for their core business.’
Completion rates are going down to about 140,000 homes a year, according to SIT, and the shortfall is soon expected to hit 1 million units: ‘From the point of view of economic theory, the state would now have to counteract the mis-development or misallocation of the housing market in the same way as a market participant. Translated, this means that the state would have to build housing itself as a provider of socially acceptable housing. From a scientific point of view, there is no alternative to this. Instead, the state intervenes in terms of regulatory policy by attempting to regulate investors and portfolio holders, which in turn increases the misallocation. Ideologically, a green policy in terms of energy savings and its cost causation as a consequence is valued more highly than the expansion of housing supply.’
However, despite the inherent gloom in the market, real estate remains one of the most exciting sectors to study, according to Gondring: ‘I tell my students that I know of no other industry that is as dynamic, varied and exciting as the real estate industry,’ he said. ‘What's more, there will always be real estate, provided we don't evolve back towards cavemen. What would be the alternative? For example, is the financial sector or the automotive industry more promising than the real estate industry? I don't think so.’
This year, he says they will have a record number of new students in the real estate management program at the DHBW. At ADI, the trend is a bit more subdued compared to 2021/2022 because the part-time paid degree programs are in pro-cyclical demand, he notes, adding that as the job risk for employees and the loss risk for companies increases, both employees and business owners are less inclined to invest in skills. ‘Despite all this, ADI is growing because we have a very diversified portfolio of studies and seminars, and the enrolment figures for 2024 make us very optimistic.’
