GLOBAL – Commercial property values in the US have already come under pressure as the spectre of rising interest rates causes uncertainty for investors.
Real estate prices fell by 1% in July, according to the Green Street Commercial Property Price Index, bringing a pause to what had been a four-year recovery.
The real estate upturn had "been put on hold for the time being as increases in interest rates weigh on pricing," Green Street said in its index report.
The news will compound fears over a potential slowdown in the real estate recovery in the US following speculation that the Federal Reserve could begin 'tapering' its quantitative easing programme as early as September.
The Real Estate Roundtable cited the interest rate rises as one of the chief concerns for investors when it released the findings of its latest quarterly survey on investor sentiment.
The report said: "numerous respondents in the Q3 survey expressed concern about interest rates and their potential to slow the recovery of assets values… the risk is that interest rates could begin to rise before property owners' net operating incomes (NOI) have caught up with increasing job creation."
Jeffrey DeBoer, president and CEO of Real Estate Roundtable, said the survey indicated "a commercial real estate sector and national economy stuck on a plateau of recovery".
In its latest quarterly outlook, Pramerica Real Estate Investors (known as Prudential Financial in the US) argued that commercial real estate was still in a "good position to benefit from the sustained economic recovery even if interest rates rise".
It added: "Against a backdrop of improving fundamentals, strong capital flows and growing net operating income, increases in 10-year Treasury rates are likely to have a limited impact on private real estate cap rates and property values. However, there are clear downside risks to pricing should policy tightening move too quickly."
There are concerns that QE tapering could also affect real estate markets in Asia.
Pramerica noted that transaction volumes in the region were likely to be weaker this year than 2012 due to investors' concerns that the Fed's "tapering of asset purchases could increase interest rates in Asia, putting upward pressure on financing costs".
European real estate investors have had less cause for concern with interest rates expected to be kept low for the foreseeable future.
Mark Carney, the new Governor of the Bank of England, suggested interest rates could be left unchanged for the next three years, but he also revealed a surprise move to link interest rate changes with unemployment levels.
Bond market reactions betrayed a lack of confidence over whether interest rates would actually actually rise before the third quarter of 2016.
Marcus Cieleback, head of research at Patrizia, told IP Real Estate that if bond yields were to rise significantly – more than 150bps – investors would "reassess the situation and possibly think of leaving real estate in favour of bonds", but he said he expected this would not happen for at least two to three years.
Crucially, Patrizia has been reassessing the appropriateness of 10-year government bonds as a benchmark for prime real estate in Europe given that lease terms have become shorter over recent years.
"The five-year government bond might be the more appropriate benchmark, giving property an even more favourable position," he said, "but also making property more vulnerable if interest rates go up."
Listed real estate investment trusts (REITs) are likely to experience greater volatility and could underperform the wider stock markets as a result of rising interest rates.
Speaking during a webinar this week, Marco Colantonio, director and portfolio manager at Resolution Capital, said: "If interest rates rise, we expect to see a negative impact on REIT share prices, particularly in the absence of economic conditions that can lead to rental growth."
He added: "Many in the industry, including ourselves, have argued that low interest rates are supportive of higher REIT prices. Now, many of the same people are arguing that rising bond yields don't matter."
While Colantonio agreed that the spread between property yields and bond yields still provided "some cushion", he said: "our view is that you can't have it both ways."
He added: "While interest rates are very important, we think there are other factors that also drive property values… If rising interest rates are accompanied by strong economic growth, then REITs should be able to grow cash flow over time, albeit more slowly than general equities, as the long-term nature of leases will generally cause a lag."