2022 was off to a more dramatic start than most of us had expected or feared. On top of high inflation and climbing interest rates, the year started with the Russian invasion of Ukraine, plunging the world into a completely new security policy situation. Meanwhile, sanctions by the western world in response to the Russian aggression have caused a surge in the prices of oil, natural gas and other commodities, along with many foodstuffs, resulting in stronger inflationary pressure in tandem with a potentially stagnant global economy.
Already in the second half of 2021, inflation was on the rise. However, most economic pundits and central banks were confident that this was a short-lived phenomenon, driven in part by supply chain disruptions due to the coronavirus pandemic, in part by exceptionally strong growth momentum on account of highly expansionary economic policies during the pandemic.
At year-end, inflation had climbed to levels not seen for several decades. In the USA, rallying prices and a labour shortage put wages and salaries under severe pressure. In Europe, even with slow wage growth, inflation increased to more than 5% year on year.
These developments served to drive up interest rates as from year-start 2022.
The fairly steep increase in interest rates has already impacted the pricing of commercial and investment property. In effect, it has served to take the top off price hikes, both directly due to an increase in financing costs, and because rate hikes have reduced loan to value ratios (LTV).
On top of this, followed the Russian invasion of Ukraine, causing substantial financial market turbulence.
The sanctions against Russia have already translated into rallying prices on energy, other commodities and food, invariably exacerbating inflationary pressure. In addition, the risk of so-called stagflation – a stagnant economy with no or weak growth combined with high inflation – has become quite pronounced.
We last experienced such a scenario in the early 1970s, back then also triggered by surging energy prices and a war: In connection with the so-called Yom Kippur War where Syria and Egypt sided against Israel, the Arab coalition threatened to cease the sale of oil to countries supporting Israel, and to up oil prices quite considerably. This caused an energy crisis, resulting in an unpleasant combination of stagnant or decreasing growth and inflation.
In the 1970s, central banks responded with rate hikes, the textbook answer to inflation. This is the right response if inflation is due to an overheated economy – but it comes at a very high expense if economic growth is weak or non-existent.
Danish commercial property market right now
Despite climbing interest rates and the potential fallout from the war in Ukraine, activity remains exceptionally brisk in the Danish market for commercial and investment property, with considerable demand from domestic and international investors alike.
In periods of high inflation and financial market unrest, real estate is considered a relatively secure investment. In addition, recent years have seen an abundance of capital allocations to the property market that still need to be invested. This indicates that demand remains strong.
Moreover, after the Russian invasion of Ukraine, some investors have started to factor in security policy risks when assessing property investments. In this respect, unlike Sweden and Finland, Denmark as a member of NATO is perceived to be a slightly safer investment destination, all other things being equal. We therefore believe that investment capital earmarked for the Nordics will increasingly be allocated to Denmark rather than to Sweden or Finland.
However, it must not be ignored that market sentiment has turned much more jittery. Danish properties remain a safe haven, but even markets considered less risky are not necessarily completely unaffected.
In a world where interest rates will tend to rise, it would probably be overly optimistic to expect sustained yield compression. Although price index adjustments of lease agreements hedge against inflation, slower economic growth momentum invariably means that future increases in the market rent of commercial premises will not match the increase in inflation. Against this backdrop, it is fair to expect recent years’ massive price hikes to discontinue.
However, in an uncertain world marked by considerable risks – in terms of market conditions and financial, geopolitical and other factors – Danish properties are, after all, likely perceived as fairly secure assets relative to comparable properties in other countries that have a less robust economy, weaker growth and/or are more exposed to geopolitical risks.
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