For real estate investors, the Bank of England’s interest rate hike last week was the latest signal that the need for a strategy rethink could be on the horizon.
The BOE increased its key interest rate for only the second time in nearly a decade. The well-flagged move was largely shrugged off, but the likelihood of further increases could lead to new pressures on the market, says Andrew Burrell, JLL EMEA Head of Forecasting.
“The rise has been largely priced in and is not expected to have major impact on real estate markets,” says Burrell. “However, it provides a reminder that there will eventually be more pressure on yields from market rates.”
Investors in the UK’s commercial and residential sectors can at least plan ahead, given the highly-predictable nature of the path the BOE is treading. The bank’s unanimous decision to raise interest rates by 25 basis points to 0.75 percent follows the path set out by the U.S. Federal Reserve, which has been pushing interest rates up since 2015.
Given current low levels of prime yields in some markets, Burrell says the concern is that a succession of rate rises could bring a slowdown in investor inflows – as happened in the U.S. when the Fed started to tighten – or lead to an upward shift in yields.
In the U.S., interest rate rises impacted real estate investment trusts (REITs) earlier this year. REITs react to rising interest rates as their yields began to look comparatively less attractive against fixed-income alternatives. However, the opportunity for rental growth can mitigate that if there are solid economic fundamentals to underpin real estate income, with low vacancy and rental growth being natural upshots of a strong economy.
Burrell says the latest decision is in line with central banks’ trend of normalisation – the process of pushing rates up from current exceptional lows to “normal” levels, currently seen as around three percent and “much lower than the old normal of five to six percent”.
“Although uncertainty remains as Brexit looms, the Bank has made no secret of its desire to follow the Federal Reserve in this normalisation of rates,” says Burrell.
“While the BOE will pause to see the impact of this latest move, further rate rises are expected over the coming quarters,” says Burrell.
The Bank of Japan held its rates this week, as did the U.S. Federal Reserve, although a rise by the latter is expected in September.
The BOE’s move comes exactly two years after the BOE cut interest rates after the UK’s vote to leave the European Union and follows the UK central bank’s first rise for a decade in November last year at a time of inflation.
Any further interest rate rises, the BOE said in a statement, are likely to be “gradual pace and at a limited extent”, giving real estate investors a sense of steadiness. Mark Carney, the BOE’s Governor, said borrowing costs will not rise sharply in the next couple of years. Monetary policy, he said, needs to “walk, not run to stand still”.
“Rates need to be higher, this is a gentle increase in rates,” Carney said in a press conference. “We stay focused on our focus for a two percent inflation target – regardless of the Brexit negotiation outcome.”
Range of Brexit scenarios
Uncertainty around the UK’s style of departure from the European Union, Carney said, should not sway monetary policy.
“There are a wide range of Brexit outcomes but in many of them, interest rates will be as least as high as they are today,” he said. “It’s not as simple as saying Brexit equals a reduction in interest rates – we cannot be handicapped by Brexit possibilities.”
Almost full employment and stable consumer confidence in the UK, as well as OECD predictions of global gross domestic product growth 3.7 percent for this year, should work in favour of UK real estate.
Despite low yields, returns from real estate continue to remain attractive when compared to other asset classes – even while interest rates rise.
Click to read more about why investors are looking to debt as interest rates rise.