Debt servicing costs in many parts of the world are becoming more expensive, with central banks from the U.S. to Asia and the Middle East slowly beginning to raise interest rates, but there is one region where borrowing has actually become cheaper in recent years: Europe.
The European Central Bank, or ECB, has kept interest rates low to negative as others have begun to hike, most recently leaving interest rates on the main refinancing operations, marginal lending facility and deposit facility at 0%, 0.25% and -0.40%, respectively.
After its April meeting, the bank said rates will remain at those levels throughout 2019—but the market is expecting an even longer hold, possibly until 2021.
That has implications for luxury real estate in the region, though it will play out differently in each distinctive market. So what should high-end property buyers make of the ECB’s decision, and how might they act on it?
It’s Not Clear-Cut
Low interest rates mean cheap debt and typically lead to rising house prices. Generally, that indicates a good time to invest, especially if the low-rate environment is expected to continue. But the full implications vary from market to market. There are 19 European Union members who use the euro, and the relationship between central bank decisions and mortgage lending is more complex in Europe than other places.
“The transmission channel from monetary policy, markets, interest rates—the bond market essentially—to the housing market is much weaker in Europe than in the U.S.,” said Frederik Ducrozet, a global strategist at the Swiss private bank Pictet. “It is much more complicated in Europe—it’s very different from one country to the other.”
And, of course, when it comes to luxury real estate, debt is sometimes not even necessary—at least not for ultra-high net worth buyers who can afford to make cash purchases.
“Quite a lot of the luxury property sector is actually driven by equity rather than debt,” said Hugo Thistlethwayte, head of Savills international residential. “Debt is always looked at because it may be convenient [to use], but it is rarely the driving force behind it.”
Low rates affect more than just the mortgage and refinancing markets, however. They tend to boost home prices across the board and stimulate real estate as an investment class, including luxury real estate. Moreover, many buyers, including affluent but not super-rich people with earned income, and those on the market for a primary home, will still use some debt.
What to Know
If you are looking to take advantage of cheap debt, remember that long-term fixed-rate mortgages are more common in some countries than others. Every market is slightly different, but Germany and France have longer fixed-rate terms than Spain and the U.K., for example.
“If interest rates start looking like they might go up, then your ability to fix now will be a drive, because you are going to be fixing for 30 years,” Mr. Thistlethwayte said.
If you are a risk-taker, however, you might bet that the ECB will not raise rates any time soon and opt for a variable rate, which is lower than a fixed one.
“You run the risk of rates going higher, but if they don’t go higher then you pay less,” said Claus Vistesen, chief Eurozone economist at Pantheon Macroeconomics.
More risk-averse buyers, especially those in markets where long-term fixed rates are not an option, might find themselves worrying about an eventual rate hike. Even though the ECB is unlikely to move quickly, real estate is a long-term investment, and rates cannot stay low or negative forever.
(Negative rates mean that depositors must pay to deposit money with a bank, rather than receiving interest on it.) In that case, consider choosing a property that can be monetized if need be, whether by renting it out or increasing its value through renovations and improvements over time.
“You are going to move into a higher interest world over the next decade; it probably means that capital growth will be slower, and therefore you want to outperform the market,” said Liam Bailey, global head of research at Knight Frank. “Things like value-add opportunities are a great way to try to outperform the average—because the average might not be very exciting.”
He also pointed to a shift in demand toward urban markets such as Madrid, Barcelona, Paris and Berlin, where owners can arrange short-term or Airbnb-style lettings to mitigate future debt costs. (That is more feasible in some markets than others; the U.K., for example, has raised stamp duties for buy-to-let investors in recent years.)
Where to Buy
Experts point to Spain and Portugal as attractive markets for investment, where prices are still recovering from the 2008 property crash.
“Those markets were absolutely destroyed,” Mr. Vistesen said.
So if you are looking to buy a holiday home somewhere warm, you are likely to get more for your money there than France, for example. And though mortgages are less likely to be fixed there, growth prospects in the region will likely offset the impact of future interest rate hikes.
“The Spanish and Portuguese markets are set for some relatively strong growth over the next 12 to 24 months,” said Knight Frank’s Mr. Bailey.
“City authorities in European markets increasingly are really trying to attract global investors into their marketplaces,” he added. “They see it as a way of kickstarting regeneration projects and kind of helping to make city economies more dynamic, by encouraging wealthy overseas investors.”
There are, however, some things to watch out for.
“Often a long, ongoing interest rate situation can spur development activity which can bring an oversupply and falling prices toward the end of the cycle,” said Zoltan Szelyes, head of global real estate research at Credit Suisse.
And if bubbles start to form, you cannot count on the ECB to step in.
“They will never hike just to tame a bubble in some country in asset prices—they are always taking this into account but, in the past at least, it’s never been a major driver of their decision,” said Pictet’s Mr. Ducrozet. “They should have probably tightened more due to what happened in Spain and they didn’t.”
“I do think you’ve got to look out for bubbles, and those that have been rising longest are probably up there,” said Savills’ Mr. Thistlethwayte.
In Iberia, major cities like Lisbon, Madrid and Barcelona were first to recover from the crisis. Mr. Thistlethwayte said he is a “big believer” in secondary cities such as Valencia and Seville, while cautioning against other European capitals including Paris, London and Amsterdam.
The Italian market, meanwhile, has been slower to take off, but Mr. Thistlethwayte said Savills currently has two successful new-build schemes underway in Rome, while Milan is becoming “a bit hipper” with more wealth moving to the city center. Those cities, he said, are worth consideration.
He also highlighted Germany’s potential and said investors are beginning to see residential property there as an investment class, rather than just a place to live. The cost of borrowing in Germany has made many occupants who would traditionally rent consider buying instead, and Frankfurt and Berlin are experiencing both domestic and international demand.
Consider the Bigger Picture
Interest rates are not the only factors affecting housing across the continent. In southern Europe, for example, many countries have implemented tax breaks and other incentives for wealthy individuals that are likely to have an even stronger impact on the market.
A number of countries have implemented Golden Visa schemes over the past decade, which allow foreigners access to the Schengen area if they invest in property. Portugal also brought in a non-habitual resident tax to incentivize wealthy foreign nationals to immigrate there. Italy, meanwhile, is in the process of rolling out a so-called flat income tax for foreign pensioners, or retirees.
And then there is the U.K., where property investors are more concerned with Brexit and the British pound than the rate environment.
“We know in London that high-end luxury prices have fallen and that’s because of Brexit, because some of those investors aren’t coming in anymore,” said Pantheon’s Mr. Vistesen. “They’re not interest-rate sensitive, they just want to be sure they can actually sell again or even live in the city, which they are not sure about.”
In Mr. Thistlethwayte’s view, the future of London’s property market “depends on what you think is going to happen with sterling, … what is going to happen with Brexit, what ability does [London] have to continue to generate money as a financial center—and it really depends on which side of the Brexit argument you come down.”
Conditions will Remain For the Foreseeable Future
Where and how to invest in European real estate depends on a number of variables—your long-term goals for the property, which bracket of luxury you fall into, whether you need to use debt, your risk appetite, and even your take on Brexit. You will also have to consider the diverging tax and regulatory environments and mortgage-lending practices in each market before making a decision.
But one thing appears certain: Interest rates in the region will be low for the foreseeable future.
“Even if rates are likely to increase at some point, we need to realize that we live in a low growth and low inflationary environment,” said Credit Suisse’s Szelyes.
So if you have been thinking about buying property on the continent, now is likely the time to do it.
“The macroeconomic environment is supportive,” Vistesen said. “The ECB’s policies are to a large extent responsible for that, because they are saying, ‘Look, we are not doing anything for a long period of time, so you go and buy your house in Spain, if you can find a good priced little house—we are not going to jump the gun in the next six months with a sharp increase in interest rates.’ That is an important part of it.”
BY PORTIA CROWE
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