After more than two years of the pandemic, the long-term impact of the virus on our living and working environment is still not fully foreseeable. However, it is becoming increasingly clear that hybrid working is gaining in relevance. Use of the home office as alternative business premises is certainly not on the decline. The Munich-based Ifo Institute reported that in February 2022, almost 40 per cent of service providers and more than 28 per cent of all employees in Germany were still working outside their actual place of work. This figure is a good three percentage points below the March 2021 peak. In fact, Jean-Victor Alipour of the Ifo Institute assumes that the option of working from home, at least in part, will be one of the long-term consequences of the coronavirus pandemic. One indication of this trend is that home office opportunities in job ads have more than tripled since 2019.
The coronavirus crisis is thereby shifting preferences for the use of office buildings and commercial real estate on a fundamental, lasting basis. But that is only half the picture. The "Investor Intentions Survey 2022" recently conducted by CBRE shows that more than half of all investors expect demand for office space to remain constant or even increase.
On the one hand, core office properties continue to be in high demand, and on the other, more than half of the respondents expect demand for office space to remain stable or even increase. Whether the current geopolitical crisis will affect this optimism remains to be seen. In any case, it is clear that modern office buildings which can reflect the guiding principles of New Work in terms of space, will become a central location for hybrid working. These spaces are used for the mutual exchange of ideas, team-building and creative work - all of which cannot be accomplished at a desk at home.
Commercial property loans have been shrinking for years
Since the sub-prime crisis in 2007 at the latest, however, banks have been acting very conservatively when granting loans and - in addition to the stricter regulations of Basel III and Basel IV - have also been keeping a closer eye on the worst-case scenario. Or to put it another way: Many financiers have become sceptical about lending for office and commercial properties, especially for complex revitalisation or conversion projects. Risk premiums are frequently demanded that can bring a project to the brink of becoming financially non-viable.
As a result, the volume of commercial financing in Germany, for example, is clearly declining. The pandemic was not the primary cause of this effect, but it has intensified it. Since 2016, when they peaked at around 76 billion euros, bank loan disbursements for commercial real estate have been falling steadily. In 2020, they dropped by almost 18 per cent due to the pandemic. At only 57 billion euros, loan disbursements fell to their lowest level since 2012 according to an evaluation conducted by the Association of German Mortgage Banks (vdp).
As a result of this development, the gap between commercial construction / transaction volumes and loan disbursements is widening. In other words, debt financing ratios have fallen from 62 percent in 2016 to 44 percent in 2020. Institutional investors from home and abroad have thereby increased their equity investments thanks to their high liquidity buffers.
Fig. 1: Construction and transaction volume as well as financing for commercial real estate in Germany 1992-2020
The enormous difference in emissions underlines how seriously the industry should take the issue of "grey energy"*
*Sources: DIW (construction volume), vdpResearch based on data from surveyor committees for land values (transaction volume), vdp based on data from associations in the credit and insurance industry and Deutsche Bundesbank (loan disbursements).
Internal financing alone will not end the drought
In the long run, however, such strong internal financing with a high equity investment is not feasible for developers, because it leads to an inefficient allocation of capital and - just like excessive risk premiums for borrowing - also to declining profitability. The new world of finance is now offering alternative, often mezzanine, finance
structures. At the same time, it is to be expected that developers will intensify cooperation with non-bank and capital market-oriented financiers. Insurers, for example, are increasingly acting as alternative capital providers for senior loans, thereby substituting banks.
Banks, however, should still by no means be excluded as traditional financing partners. In many cases, large projects with a volume of several hundred million euros can only be financed by established banks or largely so. It is now more important than ever that the project convinces the decision-makers. On the one hand, the business plan must be coherent, risks must be adequately presented and sufficient buffers must be provided in the budget. On the other hand, the real estate concept itself must convince the lenders and also meet the increasingly comprehensive sustainability criteria to which banks are attaching ever greater importance.
The green transformation is picking up speed
This is due to the fact that the ESG megatrend is undoubtedly one that financiers are focusing on. Project developers and investors as well as banks are likely to put particular emphasis on green real estate projects in the coming years. Different usage habits and increasing environmental awareness are changing demand, while at the same time ever stricter regulation is forcing the industry to address sustainability issues. The auditors PricewaterhouseCoopers have conducted an up-to-date benchmark study on the topics of the environment, social issues and good corporate governance (ESG) in the real estate industry to find out how this is affecting the sector and where it currently stands on such issues.
Accordingly, investors, fund and asset managers, portfolio holders and developers worldwide are required in equal measure to face up to changed demand and regulation and to re-evaluate risk-return profiles in accordance with these criteria. On the one hand, the momentum in the now broad, crowded ESG market shows that taking sustainability criteria into consideration can certainly prove to be a performance driver. On the other, this also goes hand-in-hand with an active form of risk management, as it seems particularly important in the case of long-term real estate investments not to finance projects or properties that might soon turn into "stranded assets".
According to the PwC study, 55 per cent of the companies surveyed stated that they will align new products with ESG criteria – while 43 per cent also intend to adapt existing products accordingly. In restructuring their offerings, providers are also responding to the massive increase in demand for ESG-compliant investment opportunities among institutional and private investors.
Mezzanine lenders and insurers are increasingly acting as financiers. Nevertheless, traditional bank financing remains an alternative
ESG conformity is becoming a key factor
The financing market will therefore diversify and increasingly turn to green real estate projects – of that there is little doubt, especially since the European Union will redirect capital even more strongly in this direction with its recent initiatives in terms of the Green Deal and taxonomy. Deutsche Bank also concurs with this view.
In its strategic outlook for the German real estate market in 2022, DB identifies ESG compliance as one of the main strategic drivers in the market.
Not only with a look to new developments, but also for revitalisation projects and portfolio refurbishments, which, according to Deutsche Bank, can generate additional returns through decarbonisation components. "The ESG dynamics are likely to accelerate portfolio adjustments in the office market towards sustainable, future-proof portfolios," the strategy paper states. And the bank has another piece of good news in store. The danger that the liquidity sources for real estate developers could dry up is thought to be low. On the contrary. "The positive investor sentiment in the office market and the high 'dry powder' liquidity levels are expected to result in further capital inflows."
Fig. 2: In your opinion, which of the following factors is a key driver for your company's strategic positioning with regard to ESG?*
*Source: Real Estate Benchmark Study 2021 www.pwc.de/de/real-estate/real-estate-benchmark-studie-2021.pdf