UK interest rate rises are expected to accelerate in the wake of the government’s announcements around tax cuts and public borrowing and will almost inevitably lead to repricing and forced sales of real estate assets, experts warn.
Residential lenders have been pulling fixed-rate mortgages from the market, due to uncertainty over interest rates, but a pull back is also understood to be forming in the commercial property market.
“Rapidly changing interest rates are making it difficult for lenders to assess the potential risk of falling property values, or indeed the expected payment difficulties of their borrowers,” said Nicole Lux, senior research fellow at Bayes Business School and lead author of the bi-annual Bayes Commercial Real Estate Lending Report.
“Fixed-rate mortgage products have been withdrawn, because lenders do not know how to price a five, ten or even 25-year mortgage into the future,” she said.
“Public debt markets have already reacted to increasing interest rates with a sharp drop of new bond issuance, while private debt residential and commercial mortgage providers have been busy running stress tests to consider any additional capital required to cover risks on their lending books.”
Lux also said the five-year Sterling Overnight Index Average (SONIA) swap rate “shows us that debt affordability is already in sharp decline”. She added: “All this will inevitably lead to forced sales amongst commercial and residential property owners, which will play strongly into the hands of capital rich investors who can pick up a bargain.”
Indraneel Karlekar, global head of research and strategy at Principal Real Estate Investors, which manages and advises on more than $100bn (€104bn) of real estate globally, said rapidly rising interest rates in the UK and US would render more “cyclical property types” – namely, office and retail – particularly vulnerable to repricing.
He said assets that are “exposed to occupier weakness” and look unable to provide rental growth will be dependent on how lenders behave in the short term.
“I think the debt markets are probably going to be less forgiving,” he said. “So office might find itself in the process of price discovery in the next 12 months.”
City of London offices look particularly vulnerable. “The turmoil we’ve seen in the capital markets last week is pretty unprecedented, and I think that’s set into place a sequence of motions where we probably expect interest rates to rise quite sharply over the next six months,” Karlekar said.
“The UK is, from a capital markets perspective, perhaps the most precariously placed right now. And I think it only adds additional pressure on the UK commercial real estate market – and the resi market, obviously,” he said.
“There is an additional complexity that has been unleashed by the new fiscal push, which frankly the bond markets have not appreciated, and now investors are having to pay the price of this additional layer of uncertainty that’s been created.”
Karlekar expects residential, logistics and alternative sectors like data centres, to hold up better, chiefly because more debt capital is available for these property types.
But in the UK he expects to see broad correction in the UK real estate market. “I think you’re going to see repricing across the board,” he said.
“City of London offices probably remains more vulnerable because this is also where vacancy levels are higher, and there’s more of a traditional financial services industry. So if we do start to head into a recession in the UK, that’s where the job losses are probably going to be. And so that probably makes me think that UK City of London offices probably more vulnerable.
“But, honestly, I think all property types are probably going to come under pressure, because your cost of debt calculations have completely changed.”
But “an important caveat”, Karlekar added, is that, for sectors like logistics, ”expectations of underlying occupier growth are still very strong, and if you look at rent growth forecasts, they’re still pretty robust”.
He added: “So even if yields do shift out a little bit, lenders are going to be far more forgiving, because they will see that the landlord has the ability to push rents pretty hard… whereas [for] office, you’re going to be very hard pressed to see landlords push rents.”
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