Capital Economics has warned that real estate could be the “weak link” when it comes to the effects of tightening monetary policy.

The economic research consultancy said certain markets, most notably in the residential sector, were most vulnerable in an environment of rising interest rates.

A report by senior economic adviser Vicky Redwood published today said: “Having been propped up by low interest rates and bond yields for over a decade, property markets will certainly be tested as monetary policy tightens. How they fare will depend in large part on just how far interest rates rise and what impact quantitative tightening has on financial conditions.”

She warned that while modest rises in interest rates was only likely to cause price falls in a few select markets, “rates might have to rise only a bit further than we expect to cause more widespread falls”.

The housing markets of Canada, Australia, New Zealand and Hong Kong appear vulnerable to even a modest rate in interest rates, according to Capital Economics.

“And there is a risk that interest rates will need to rise above their equilibrium in order to get inflation under control. In that case, we could be looking at more widespread falls in prices,” Redwood said.

“While this would not cause a second global financial crisis, it would still weigh on economic growth in the countries concerned and could cause interest rates to start falling again in some places.”

Relative to the residential sector, commercial real estate appears more resilient. Valuations “look less stretched than those in the residential market”, the report said, and there “is also little evidence of any re-emergence of the toxic combination of rising values, spiralling debt and risky development activity that has brought about commercial property downturns in the past”.

Despite that, Capital Economics is still forecasting a rise in commercial property yields between now and 2026, ranging from 15bps for the euro-zone to 35bps for the US, implying a hit to capital values of between 5% and 10%.

“In context, this yield shift is comparable to the mild jolt see at the start of the pandemic, though with a less severe impact on values as it is spread over several years,” Redwood said. “And values are unlikely to fall overall, as the yield effects will be offset by rental growth.”