The anticipated rate hike, which many analysts believe is on the horizon will do little to dampen commercial property values, according to the latest white paper from global property company, Colliers International. Today’s remarks from Mark Carney, Governor of the Bank of England have done little to change this view.  His comments about spare capacity and public/private balance sheet deleveraging suggest that any rises are still some way off and in his words “that interest rate levels in the future are likely to be materially lower than in the past.”

Despite Carney’s comments that interest rates could reach 2 per cent in three years’ time, an interest rate hike remains very unlikely in the next two years, according to Colliers research.  Even a modest rise, such as that which Carney alluded to, would do little to unhinge property demand, given the scope for further price rises (yield compression) brought about in part by the extraordinarily low rate at present of 0.5 per cent.  Additionally, a strengthening economy will support occupier markets, lower vacancy rates, encourage rental growth and boost cash flow, all which will act to increase the appetite for property assets further.

Dr Walter Boettcher, Director of Research & Forecasting, EMEA commenting on his latest whitepaper - Will interest rate rises undermine commercial property values?  - says:  “In tracking the UK economy and property markets it is clear that much forward looking attention is shifting to understanding business cycles, inflation expectations and especially the likely path of interest rates and  gilts.”

“From a property perspective, interest rates are important, not merely as an indicator of debt costs for asset acquisition, but also as a means of evaluating the pricing of commercial property assets.  If the 10 year gilt rate is considered the ‘risk-free’ rate, then commercial property yields are often understood as the 10 year gilt with added risk pricing.  If gilts do not move and the economy strengthens, then surely the required risk will fall allowing property yields to fall further with scope for further capital value growth.”

Interest Rate Expectations:

  • Gilts are the risk free rate and together with property investment risk form a basis for pricing of commercial property
  • Gilts are also linked to base rate levels. If base rate do not rise, gilts are also unlikely to rise, providing scope for further commercial property yield compression
  • Base rates are unlikely to rise for several reasons including: 
    - reliance of the recovery on household spending
    - exchange rate constraints and international competitiveness
    - benign inflation and deflation risks
    - control of government debt costs
    - the possibility of a mid-cycle economic slowdown
    - the availability of alternate macro-prudential tools to target sector bubbles
    - the UK general election
  • The Eurozone base rate horizon is impacted by many of these same factors as in the UK, except there is a greater threat of deflation.  It is unlikely that the ECB will raise rates for the foreseeable future
  • Commercial property yields (cap rates) have scope for further compression over the next two years, both in the UK and Europe; given that pricing is still a long way from the market peak in 2007.