Interest rates and real estate: A look at the current landscape and outlook
The global economic landscape is rapidly evolving. With inflation moderating but still at some of the highest levels seen in decades, policymakers remain focused on price rises as a key risk to the economy. Interest rates appear close to their peak – but some further rises are still anticipated in many countries, given that economic growth is holding up far better than previously anticipated.
However, expectations that interest rates will return to their previous low levels are misplaced. Rates will be cut from their current levels – but inflation may well prove sticker than policymakers would like, and we believe interest rates will remain “higher for longer” before rates are reduced during 2024.
What do higher interest rates mean for real estate?
Higher interest rates are expected to impact the pricing of real estate in two significant ways:
- By raising return requirements across the spectrum of investment assets in response to a higher risk-free rate.
- By increasing the cost of debt that is used by many investors to finance their real estate purchases. (see the chart below on Five-year Swaps)
How has this impacted the spread of property yields over bonds?
The steady rise in interest rates over the course of 2022 has eroded the spread of property yields over government and BBB corporate bonds. This is already leading to rising property yields and falling values in markets around the world. Repricing has occurred most quickly in the UK, but we expect other markets to follow suit in the coming months in order to remain competitive in comparison to bonds.
Our analysis points to investment sales time lagging a change in corporate bond yields by around 12-18 months. Given that bond yields began softening in late 2021, and the elevated stress in the banking sector that emerged in March 2023, it seems likely that the recent slowing of property sales volume will extend through the first half of 2023.
What does this mean for property investment right now?
For property, the investment strategy of 'buy the asset and ride the yield compression' is off the table for most sub-sectors for many years to come. Asset management and rental growth will become central to a successful property strategy.
How can I learn more about the current state of interest rates and real estate?
Download our full report for a look at the changing economic backdrop, property market context, return expectations and the cost of debt, impact on transaction volumes, current outlook summary and more on this topic.
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