EU real estate investors face negative rates shock
Negative interest rates have property investors facing a counter-intuitive quirk: their borrowing costs can actually rise as interest rates fall.
This is a mounting concern for many property investors, given the potential for rates to decline further as central bankers try to spur economic growth, according to lobby group Commercial Real Estate Finance Council.
The impact is being felt in particular by property investors taking out floating-rate loans.
While investors broadly benefit from record-low borrowing costs, “the more negative rates go, the higher your borrowing costs can go”, says Olivier Elamine, chief executive at German property firm Alstria Office REIT, which manages around $5.4 billion of office properties in five German cities.
The reason lies in the structure of interest rate swaps, common financial products sold alongside loans and designed to insure borrowers against rising rates.
It’s not going to kill real estate deals. But it’s not a happy surprise
Property firms typically borrow through floating-rate loans, whose interest payments move as prevailing rates change. At the same time, they buy interest rate swaps that convert those floating payments to fixed amounts, which line up better with their steady streams of rent.
The swap works like this: If rates rise, the property firm gets extra payments from its swap counterparty; if they fall, these extra payments fall.
This worked fine until rates went negative. That is because banks making loans had the foresight to include a safety net for themselves, according to CREFC: even if prevailing rates fell below zero, the loan itself could never have a negative interest rate.
But swaps typically don’t have a floor. When rates fall below zero, the property firm has to pay the swap counterparty more — while the amount it pays the bank stops falling.
This extra cost has stung many property companies, says Mark Battistoni, managing director in London at US-based financial advisory firm Chatham Financial.
The more negative rates go, the higher your borrowing costs can go
“It’s not going to kill real estate deals. But it’s not a happy surprise,” he adds.
Elamine was first confronted with the potential mismatch in 2013 when refinancing a $946 million bank loan.
“We would be worse off today if we didn’t spot it,” Elamine says. Alstria is saving about $1.53 million a year over the life of its seven-year loan, he says.
To avoid unintended payments, Alstria didn’t buy a swap. It bought another financial product, called a cap, that effectively fixes its floating interest rate regardless of whether the reference rate is positive or negative.
Not all investors are concerned. Given the issue has arisen from negative rates, borrowing right now “is still phenomenally cheap”, says Mark Terry, funds chief financial officer at British property firm Tristan Capital Partners.
The Wall Street Journal
This article originally appeared on www.theaustralian.com.au/property.
