Following an unprecedented boom, the real estate industry is facing what is probably the biggest challenge in its history. Project developers in particular are being hit hard. News of ailing companies has dominated the headlines for months; several industry giants have already filed for insolvency. Rising construction costs, delivery bottlenecks and the sharp rise in interest rates before the previously historically low level have caused their calculations to collapse like a house of cards. enomyc author and distressed real estate expert Janina Elisa Buchholz explains how it came to this, what options for action now remain for the companies and for whom the crisis also offers opportunities.
The fall could hardly be deeper. After flying high with fantastic margins, many project developers have come crashing down hard in recent months.
There are several reasons why it has come to this. On the one hand, many German cities have invested more in municipal development projects in recent years in order to improve the infrastructure and quality of life. In this investment climate, many real estate developers succeeded in landing new projects. At the same time, Germany's political stability and strong economy made it increasingly attractive to foreign investors. Thus, investment activity by non-German developers in the German real estate market has increased significantly in recent years. Already in 2015, 68 per cent of commercial real estate buyers were foreign investors, while only 32 per cent came from Germany.
Another, - if not "the" - central reason for the boom in the sector are the exceptionally favourable financing conditions until a few months ago. Margins above the 15 per cent mark were not uncommon in the low interest rate environment via leverage effects - and often not too difficult to realise. Even expensive subordinated financing could hardly jeopardise profitability in the long term.
From today's perspective, it is clear that the development oft he market acted like a rose-tinted filter over the companies like a soft focus, also over calculation and management errors. Many real estate developers were increasingly willing to take risks. The equity base was partly strengthened via mezzanine, the risks resulting from the correspondingly ambitious interest rates were ignored. The industry, spoiled by success, seemed simply "too successful to fail".
The further outlook: not very encouraging
There are currently few signs that the critical situation of the companies could quickly change for the better. Sharply rising real estate prices have led to partly unrealistic expectations of sales factors and of the projects themselves. Many of them are also not calculated sustainably on the cost side and, moreover, are financed with a (too) low (real) equity share.
In addition to the shortage of skilled workers and fluctuating construction and material costs, regulatory hurdles are causing problems for the industry: Ever stricter building regulations and increasing environmental requirements, but also requirements for ESG compliance, continue to drive up costs and put pressure on profitability.
And although increased interest rates and inflation already make financing more difficult than in previous years, financiers' requirements for equity ratios and collateral are growing.
But things have also changed in the general setting. Due to the trend towards working from home, companies need significantly less traditional office space. Political uncertainty and less than favourable economic conditions are making reliable planning and clean calculations increasingly difficult. Where the rose-tinted filter previously bathed many things in a favourable light, project developers now find themselves in the piercing glare of a burning glass.
Risk minimisation is the order of the day
Particularly in larger projects, there are usually complex interdependencies between planners, builders, tenants (possibly also buyers), financiers and clients. This and the usually long project durations further increase the risk.
This makes it all the more important for companies and financiers to set up a functional and attentively adjusted risk management system and to maintain it throughout all phases of the projects. Professional construction controlling with a corresponding performance profile as well as a regular critical review of updated development calculations are also part of the obligatory programme in terms of risk minimisation. In addition, the cost and revenue parameters agreed upon when granting loans should be continuously reviewed and plausibly positioned on the often dynamic project timeline. In this context, the demands on financiers with regard to the scope and design of risk management have risen steadily in recent years due to the regulatory framework and Europe-wide regulation.
In ongoing projects, there can always be extensive unplanned interruptions in the project and construction process. Causes for this can be (sometimes only temporary) liquidity bottlenecks and budget overruns, but also management mistakes, unforeseeable changes in the market or events in the construction process not taken into account by the developer or borrower, such as insolvencies of contractors or planning or execution deficiencies with sometimes serious consequences. In this situation, there is often a need for external advice to accompany and support complex project situations that are challenging from a financial, real estate or construction point of view, in particular to counter project and construction standstills in a solution-oriented manner. For example, our mandates focus on the plausibility of development calculations on the cost and revenue side, monitoring project progress in accordance with the project plan and, if necessary, support in the further implementation of the project in an advisory and controlling function, evaluating project-specific real estate economic and (real estate) legal framework conditions, determining any additional financing requirements and risk positions and preparing decision-ready, suitable documents for financing partners.
In the medium term, hope remains that the market situation will normalise as a result of the lower demand already observed and the resulting drop in construction costs and sales prices.
While many project developers are currently fighting for survival, a gold-rush mood is spreading among equity-rich investors. For family offices, for example, the current crisis offers a good opportunity to expand their portfolios. How successful their investments are and what this means for potential users, however, remains to be seen.