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As Basel IV enters into force, real estate professionals are bracing for its impact on credit conditions and capital costs. At a recent LuxReal event co-hosted with Banque de Luxembourg, experts from banking and real estate shared insights on the regulatory shift and its likely consequences for the sector.

It was a particularly technical regulatory topic that LuxReal chose to address in collaboration with Banque de Luxembourg on May 21. The event took place in the bank’s auditorium, where members were invited to attend a conference entitled Basel IV and Real Estate: Navigating the Regulatory Shift. The goal was to better understand how the new Basel IV regulations, which apply to credit institutions, could impact the financing of real estate projects.

A new framework

To shed light on the regulatory developments, Alix Tchana, Partner in Finance & Risk Consulting, began by outlining the key points of the reform and how it could affect banks’ risk assessments and their approach to supporting real estate projects. The regulation primarily aims to clarify the minimum capital requirements for banks, as well as expectations regarding prudential supervision and market discipline. “This new framework will have an impact on banks’ commercial strategies and on the structuring of their products, particularly in terms of loans and pricing,” he noted. The new requirements will affect both risk-related costs and capital costs, especially in connection with granted loans.

In the real estate sector, the risk assessment of financing—and therefore the associated capital requirements—will depend on several factors: the nature of the asset (residential or commercial), the project’s development status (built or under construction), and its ability to generate regular income. “Each project will need to be assessed based on precise criteria to determine the risk weighting,” the expert explained. While Basel IV will indeed affect lending practices, its impact will not necessarily be negative. Depending on the case, access to credit may become either more restricted or more flexible.

Capital requirements become more risk-sensitive

Following this introduction, a panel of banking and real estate professionals exchanged views on the topic. Summarizing the key takeaways, Matthias Moersdorf, Director of Finance & Risk Consulting at KPMG Luxembourg, emphasized that assessments will increasingly need to rely on high-quality, precise data, including ESG criteria. “The capital requirement thus becomes more risk-sensitive to the nature and valuation quality of the mortgages,” he commented.

A particularly inopportune time

Moreover, this new regulation is set to come into effect in a challenging market context, marked by a steep rise in interest rates and a decline in transactions—putting developers under significant pressure. “Now, we are starting to see a plateauing of cap rates in conjunction with the stabilization of ECB interest rates, and in some markets, slight yield compressions are also appearing,” commented Olivier Catusse, Managing Partner and CEO of KanAm Grund Group. “The patient was very sick and is just beginning to show signs of recovery. Additional burdensome regulations on banks are not helping an industry in which banks should play an important role in the recovery.”

For Michel Weckering, Deputy Head of Enterprises & Entrepreneurs at Banque de Luxembourg, these developments are arriving at a particularly inopportune time, even though it is difficult to assess their full impact. “There is no one-size-fits-all answer to this question. Some activities (such as early-stage developments) will be more affected than others (such as buy-to-let),” he said. “But in general, from the banks’ perspective, the cost of capital is expected to rise. This should lead to revisions in allocation strategies, with more selective approaches to financing.”

A cost impact of around 20 to 30 basis points

In light of the new regulations, banks will need to adapt their strategies. “The basic regulatory idea is to reduce real estate risk exposure on banks’ balance sheets. So yes, on average and all things being equal, it will affect risk appetite. But the current crisis hitting the real estate sector and reducing risk appetite is probably having a much stronger impact than Basel IV alone,” Weckering explained.

The effects will be felt gradually, as banks reposition themselves and reassess their capital allocation strategies. “It’s difficult to estimate the exact cost impact at this stage, as some fundamental aspects of the regulation are still pending. But we anticipate an increase of around 20 to 30 basis points. This may seem significant at first glance—but compared to the rate fluctuations over the past three years, it remains relative,” he added.

Added pressure

For developers and promoters, however, the news is far from encouraging. “Our margins have already been significantly squeezed in recent months due to current market conditions,” commented Eric Lux, Chairman of the Board at IKO Real Estate. “These new measures will further weigh on our profitability by increasing financing costs. Banks will enter the process later, at more advanced and less risky stages of the projects. This will force us to seek alternative sources of financing. Off-plan sales will become more complex. Meanwhile, construction costs continue to rise. Higher-cost loans will automatically affect yields and reduce the exit value of the building for the developer. In this context, developers will need to be smart, agile, and find ways to maintain their profitability.”

Exploring alternatives

What financing alternatives can be explored in such a context? “Values are down. Banks are no longer offering the same LTVs they used to. Owners are focusing on preserving liquidity. Total interest rates have risen,” summarized Olivier Catusse. “When you put both together, investors begin to explore alternative capital structures—stretch senior, whole loan, mezzanine, etc. These structures are more complex from a legal standpoint, as they require intercreditor agreements, and they are more expensive, but they do exist. They allow sponsors to deploy less equity. This is where alternative lenders such as debt funds and insurance companies come into play.”

Investors and developers, however, remain particularly sensitive to the cost of credit. “Private equity, family offices, debt funds, and real estate co-financing are all alternatives to consider. We will need to find ways to adapt the cost of that financing. But it won’t work at a 15% cost,” concluded Eric Lux.

According to Michel Weckering, although the sector is facing numerous challenges, banks will remain reliable partners for industry players. “The crisis is impacting the market and its financing conditions much more than Basel IV or other regulatory changes,” he concluded. “I’m convinced that banks will continue to play an important role in supporting the sector—though with some necessary adjustments.”