Boom, Inflation, & Catching Up
- Topic
- Inspiration & Information
- Date
- 26.09.2022
- Share
Between an economic boom, inflation catastrophe, and catching back up again: real estate development remains a solid business model ...
Is the real estate market overheating? Is a bubble about to burst? Are Austrian prices going to reach international ones? Or is the market just clearing itself? And very important: Is AVORIS ready for rising interest rates? We recently discussed this complex set of topics with a small group of people who invest in AVORIS projects. We have compacted and summarized the essence of the extensive discussion:
The Business Model
As a project developer (“trade developer”), the AVORIS business model is all about developing real estate and selling it at a few percentage points of markup above the costs. This works as long as land and construction prices evolve at a rate similar to real estate prices. This was indeed the case between January 2021 and May 2022. Both the construction cost index for residential and settlement construction and real estate prices rose by around 26 percent.
However, it is worth noting ...
how the general inflation rate has developed in comparison to this. We see here two completely different phases:
While the overall inflation rate was around 3 % in the first half of 2021, real estate prices ran rampant in comparison at around 15 %.
Between July 2021 and June 2022, a reversal was imminent. Real estate inflation fell to about 10 %, while overall inflation rose to around 8 %.
Since July 2022, everything changed again: Real estate prices have fallen slightly, and inflation remains high. It is uncertain how things will develop in the future.
We here at AVORIS are assuming that construction and real estate prices will align with the overall rate of inflation in the medium term. In the interest of our investors, it must be our goal to generate sufficient profits from our projects to be able to pay a fair interest rate. In many properties, this can be done by optimizing floor plans and maximizing energy efficiency. By constantly adjusting these two parameters, we are able to keep yields and rents at a reasonable level.
Are we prepared for rising interest rates?
There are two answers to this question:
On the one hand: For real estate development projects, interest is only a minor cost factor. The total costs of financing—i.e. interest plus processing and registration fees—usually amount to less than 5 % of total investment costs. Processing and registration fees are often higher than any interest payments. For this reason, interest rate increases during the development phase affect us only marginally.
The situation for long-term investors in existing building is entirely different. At some point, a real estate investment with high inflation and low returns is no longer worthwhile for investment foundations and buyers.
As soon as this in turn leads to reduced demand by long-term real estate investors, the result would likely be a reduction in construction work and demand for development properties. This would depress construction and land prices, which in turn would make the development business attractive again.
Our conclusion: Real estate development
is still a solid business model!
From our point of view, the current developments are risky for two groups:
The first group is investors with little capital who had hoped to build up a large real estate portfolio with a significant amount of borrowed capital. If they bought at high prices, it will be difficult to repay the installments now that interest rates are rising.
The other group is real estate developers with little capital who based their calculations on continually rising prices and have no fallback scenario when renting out the completed property.
AVORIS has never allowed itself to be driven by continually rising property prices. We have refused the hype and instead built up a competent team and a strong network of banks and investors. Thanks to our conservative calculations, we can look towards the future with confidence.
