European market volatility provides real estate debt opportunity

Market conditions remain volatile amid higher interest rates, inflation and the threat of looming recession. In such an environment, investors are struggling to meet return requirements. However, asset classes such as commercial real estate (CRE) debt could offer the potential for value across short, medium and long-term timeframes, while adding effective portfolio diversification. 

Economies throughout Europe are feeling the strain with the continued fallout from the COVID-19 pandemic, Russia’s invasion of Ukraine, substantial energy and food cost increases and the resultant cost of living crisis. 

Figure 1 shows that 2023 economic activity in European countries, as measured by gross domestic profit (GDP), is projected to fall compared with 2022 growth. Rapid and substantial interest rates increases mixed with higher inflation is causing GDP to fall. These interest rate increases have also resulted in the cost of borrowing against CRE debt now being higher than the equivalent yield available from direct investment in the same property. While this rapid change is proving troublesome for borrowers, the growing cost of borrowing offers increased returns for debt providers. 

These current challenges in the CRE debt market, however, are potentially outweighed by a positive outlook. Rising interest rates, which are unlikely to soften in the short-term, the lower supply of debt and increased lender pricing power have created a strong platform for debt investment opportunities. Weaker currencies have also created an environment that invites foreign investment, particularly US-dollar investors, as currency correction over the medium term could boost returns.

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