Property Faces a Slow Reckoning as Interest Rates Rise

bring back uncomfortable memories of the years leading up to the 2008 financial crisis. Commercial landlords who learned useful lessons about debt since then—except to carry less of it—face a slow reckoning.

While interest rates have been rising faster in the U.S., Europe’s real estate owners look more vulnerable to pricier debt. Listed property stocks in the euro area carry net borrowings of 14 times their projected earnings before interest, taxes, depreciation and amortization on average, according toFor the first time since 2009, borrowing costs for the euro-area property industry are now higher than the return many investment-grade assets can earn. The average cost of debt is 4.

But companies still need to refinance up to 15% of their borrowings every year. As more debt matures, earnings will be eroded by 3% to 7% annually from higher interest bills depending on the type of property, according to Bank of America. Some landlords will be able to offset this with rent increases, but probably not owners of offices or shopping malls as demand from tenants is weak.

Falling valuations are also a risk. As financing costs rise, buyers will only make an acceptable return from property if they pay less. They are growing reluctant to sign deals at today’s high prices. Purchases of commercial real estate in Europe were down 9% in the second quarter of 2022 compared with a year earlier,A dip in valuations would send real-estate companies’ loan-to-value ratios up. Some landlords will need to unload properties to avoid breaching covenants.

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