Slowly but surely, global central banks are paving a path toward higher interest rates for the first time since the financial crisis.
Commercial real estate investors are keeping a close eye, aware that policy changes can have a big impact economies and financial markets.
The Bank of England (BOE) in November raised its key interest rate for the first time in a decade. The European Central Bank in October said it will scale back its bond-buying program, a signal it intends to follow the U.S. Federal Reserve toward higher interest rates.
The Fed has been pushing up interest rates for nearly two years and, in December, is widely expected to deliver its third rate increase of 2017.
“If I’m thinking about holding onto commercial real estate over the next few years, this will be on my mind,” said Ryan Severino, Chief Economist at JLL. “I’d warn against complacency.”
But incremental shifts in policy are not likely to roil real estate markets, at least in the short term. One big reason: the global economy is growing, which should push rents higher and vacancies lower.
Global gross domestic product growth will hit 3.5 percent in 2017 and 3.7 percent in 2018, an increase from three percent in 2016, according to the OECD.
“As long as the global economy continues to grow, there’s not a lot of downside to rising rates,” Severino said. “We might argue real-estate valuations are high, or in some parts of the world too high. But in general, global economic growth is good for real estate.”
Another benefit for real estate: Returns remain attractive compared to other assets like bonds. Even while interest rates rise and property yields hit all-time lows, the difference is wide enough to maintain strong investor demand.
A year ago, the interest-rate picture in the U.K. was very different, with the BOE having cut rates for the first time in seven years after the vote to leave the European Union.
But an improving economic background and rising inflation have shifted the debate. November’s decision saw the BOE raise key interest rate to 0.5 percent from 0.25 percent, its first increase since July 2007.
“The pace at which the economy can grow without generating inflationary pressures has fallen relative to pre-crisis norms,” said Mark Carney, the BOE’s Governor. “Over the next few years, modest demand growth is expected to use up the little spare capacity remaining in the economy. Domestic inflationary pressures are likely to build.”
The BOE’s rate increase was a sign “the economy is heading back to normal,” said Andrew Burrell, Head of Forecasting for JLL in EMEA.
Caution is advisable in prime U.K. markets where investor demand has been strong in recent years, including central business districts and prime shopping centers, he said.
“But there are plenty of other markets that look to be very good value,” Burrell said. “Investors should really be considering a move up the risk curve.”
The BOE’s policy shift sparked a concerns around whether the hike was premature, in part due to uncertainties over Brexit.
Two years ago, the Fed’s first rate hike was met with similar skepticism with some economists concerned that the economy wasn’t strong enough to start reigning in policy support.
But two years later, the Fed’s decision “doesn’t look like a wrong move,” Severino said.
“The BOE can look to the Fed and show them that they ran with this for two years and it didn’t have too big an impact on the economy,” he said. The BOE “can hope to follow a similar path.”