World Out Of Whack: What’s Next For Global Real Estate?

After insurance, maintenance, any tenant vacancies, and other opex you’re definitely underwater. A great question and one that many investors are going to be asking themselves while staring in the mirror at some point in the next few years.

The answer actually lies not in math but in human behaviour and expectations.

When rates continuously moved lower and then lower still as coordinated global central banks held rates down, buying in anticipation of ever cheaper financing costs made a lot of sense. Plenty people have gotten very rich doing it over the last few years.

Even just a 25bp move on debt financing on a multimillion portfolio of assets translates into a a heck of a lot on the asset price revaluation. And what’s more is that the guys buying negative yielding assets woke up a few short years down the track to a situation where cashflows had turned positive (financing costs moved lower) on top of the price appreciation which has been enormous. That’s how leverage works and that’s how linear assumptions get made well into the future.

Now let’s get back to our story and say lending rates rise by 200bp to 6%. The market will immediately begin to reprice all assets, including our mythical commercial building.

What are we prepared to pay for this place in a 6 cap environment?

Our interest expense just went from $40k to $60k – a 50% increase.

$40k of income used to service $1m of debt but at a 6 cap it only services $666k – a nice 33% equity haircut.

Except, of course, that’s not at all how markets work.

They are forward looking, and so when the market finally figures out that financing costs (rates) are heading higher not lower for longer, then they begin pricing in this reality and cap rates go higher than financing costs, sometimes much higher. What happens to the equity? My guess is we’re going to find out.

On Friday I’ve got a follow up article from a good friend of mine, which gets into a particular sector of the market where this is likely to hit hard.

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Disclosure: None.

Disclaimer: This site is not intended to render investment advice.None of the principles of Capex Administrative Ltd or Chris MacIntosh are licensed as financial professionals, ...

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