Hoping interest rates will fall is not a strategy

As we pass the mid-year point in 2023, the real estate industry continues to face many challenges, by Darius Divwalla

Economic data releases are conflicting, which adds to the uncertainty.  Although the consensus is that UK interest rates will shortly peak, offering a chink of light, we do not yet know how quickly and by how much interest rates will fall.

As we adapt to life in a low growth economy, where the universe of lenders is smaller and cheap debt is off the table, the rate of returns that real estate funds managed to achieve over the past decade may be difficult to sustain. This low growth economy could lead to an equity gap and challenges with the capital structures at a time when EPC targets are looming.

Repairing capital structures now allows managers to be better positioned to take advantage of the upswings when they do come. Hoping interest rates will fall and that affordable debt refinancing will become available are not actual strategies simply because neither may happen.

Even if rates are suddenly cut from where they are today, many borrowers are still going to struggle to plug equity gaps and repair their capital structure. This is in addition to those borrowers whose existing loans are maturing and have few refinancing options. Traditionally, securing refinancing meant either the borrower putting up more cash to cure the default or offering some additional security. The lender could waive a breach. Or it could demand a sale.

Raising cash from real estate investors is an option, although going back to original investors for cash is always a challenge and going to a new investor also brings uncertainties. For one, new investors often have vastly different agendas. They may want to rewrite the business plan, cut fees, demand a priority return on their investment or even some security. The new partner coming to save the day is not doing it for free, and the cost of capital during tough times can be painfully punitive.

Another option is to bring in a joint venture partner, however joint venture agreements bring their own complications and are inherently inflexible.  This may bring problems when the market changes, to say nothing of the risk that the JV partner turns out to be Darth Vader.

It makes sense to consider other financing options.

At IPSX, we offer a different solution to help repair capital structures and, where necessary, upgrade real estate to meet EPC targets. A building owner can sell equity shares to professional as well as retail investors in the building, by taking part in a real estate IPO on IPSX and use the proceeds to repay debt. Not only can this approach help plug that equity gap, the cash raised can be used to retrofit and refurbish buildings to achieve looming EPC targets.

More importantly, the IPSX solution is flexible.  The building owner can choose whether to sell a minority stake, a majority stake or, indeed, the entire asset, in accordance with their needs.  Further, as the market changes, the owner can choose to sell further shares in the asset, or even buy back shares. Third party investors in those shares should be supportive as they will have bought into the building owner’s vision from the outset of their real estate investment.

Even if rate cuts begin sooner rather than later, some borrowers could still find things challenging for the foreseeable future. For many, the time for sitting tight and hoping for the best may have already passed. If you are unhappy about the direction of travel you could be better off grasping the nettle, approaching your capital structure with a fresh perspective, and taking meaningful and positive steps to preserve the future value of your assets.

Darius Divwalla is Director, Capital Markets, IPSX, the world’s first regulated stock exchange dedicated to trading real estate.