With the tide now turning on interest rates, EPRA CEO Dominique Moerenhout evaluates what central bank cuts mean for the listed real estate sector.
The 2022-2023 interest rate hike cycle was the steepest, most aggressive of its kind in 40 years. With the ECB cutting rates for the first time since 2019 in June, and the Bank of England following with a quarter point reduction last week, much has been made of what this will mean for the commercial property sector and its end customers.
Since both rate cuts were widely expected - and to a certain extent priced in by the markets - all eyes are now on the ECB’s next rate move and, over in the US, the tack taken by the Federal Reserve. With eurozone inflation coming out higher than expected in July, another rate cut by the ECB in September may be a close call, say market watchers.
Nevertheless, now is a good time for the sector to take stock and evaluate the impact lower rates will have on listed real estate (LRE). Set against a changing political environment across Europe there is a real opportunity for the sector to see this bumper election year as the beginning of a new dawn and seize it in order to turbocharge growth and unlock value for LRE.
Refinancing loans
As all of us working in real estate will know – whether in the public or private sector – the significance of interest rates to property markets should not be understated as the key factor influencing the cost of capital, on which so many real estate transactions and development projects depend.
With that in mind, the rate cut we’ve seen in Europe and the one from the Bank of England will start making it easier to refinance loans against properties that were transacted before rates were initially hiked in early 2022. It’s not to say a small, 25 bps rate fall is a quick fix: we’ll likely need to have further falls before there is any true impact on re-financing or any stimulative benefit is felt. But, it’s certainly a step in the right direction.
That’s important as 18% of debt belonging to European LRE is set to reach full maturity in 2024/25, and a further 38% is set to reach full maturity in 2026/28 – when most expect and hope that interest rates will have returned to more ‘normal’ levels.
What’s more, when it comes to debt, European LRE comes in much more favourably: LRE leverage currently sits at 38%, whilst direct real estate (DRE) is over 50%. While, in theory, leveraging can magnify returns, it can also amplify losses.
Confidence and investment
Even though rate cuts have been long-anticipated and widely telegraphed, unified action between Europe and the UK is a signal that economic consensus is once again returning, which will no doubt boost global confidence in the LRE sector. A return to managed expectations and normality means that investors and businesses alike will be able to move forward with greater certainty.
And as we see confidence rise, so too should we expect investment to flow more freely into LRE. Lower borrowing costs and the possibility of capital value appreciation will likely begin to improve both underwriting ability and willingness, while increasing liquidity.
At the same time, as we have seen in recent months, asset managers are converting some illiquid open-ended funds into liquid hybrid models which hold equal positions in direct property and REITs, alongside a small cash allocation. Such moves are a demonstration of confidence in the liquidity, transparency and diversification offered by the LRE sector.
Looking ahead
With the tide now turning on interest rates, in order to foster a climate for growth, the sector must now turn its attention more directly to real estate investment trusts (REITs) and the LRE sector at large.
LRE has historically fared well at similar rate-related inflection points, outperforming broader equities and bonds. Having corrected sharply in 2022 while delivering strong operational performance and earnings growth, REITs are now offering a unique entry point for long-term investors, relative to broader equity markets.
LRE is definitely a key component of a well-balanced real estate investment portfolio. Not only do listed REITs provide the liquidity direct real estate (DRE) can’t, but they also respond more positively to market movements compared to the private market. As a result, REITs are poised to become an increasingly appealing asset class for investors seeking optimal allocation to real estate.
As rates look to settle back down to more normal levels, the LRE sector has a prime opportunity for a significant ‘reset’ moment to fuel growth. Yes, the last few years have been hard, but through it all, the sector has demonstrated great resilience. Now, when better days look to be on their way, it is our moment to move beyond resilience and achieve meaningful growth... to investors’ benefits.
