The Bank of England has raised UK’s interest rate for the second time in 10 years, but the impact on property is expected to be limited, observers have told PERE.
Up 25 basis points, to 0.75 percent, the interest rate is edging slowly toward what the country’s central bank deems is the new normal rate of 2-3 percent. Bank of England governor Mark Carney said there will be “gradual” and “limited” rate rises in the future, calling last week’s move “a modest tightening of monetary policy.”
UK real estate managers had a muted reaction to the change, which, they say, was widely expected.
“Of more significance was the Bank of England publicizing its estimate of the equilibrium interest rate for the first time,” Sabina Kalyan, the global co-head of research for CBRE Global Investors, told PERE. “The Bank is arguing that UK interest rates will rise to around 2-3 percent over the cycle – well below the pre-Great Recession [average rate] of 6 percent. This suggests that interest rates will continue to rise slowly and steadily; they will cap out at levels that remain fairly supportive of UK real estate investment.”
She added that real estate pricing in the UK is now more affected by structural than cyclical trends, such as bankruptcies depressing the retail space and e-commerce driving industrial demand.
Like Kalyan, others highlighted a longer-term perspective.
“This [decision] is significant yet unsurprising,” said Ludo Mackenzie, the head of London-based debt fund manager Octopus Property, noting the change “should be welcomed. Yes, there will be winners and losers, but over the longer term it is to be expected that rates should normalize, something that is in the interest of a properly functioning economy.”
In a report last month, London-based M&G Real Estate pointed to the US, where interest rates have been rising since late 2015, as a precedent for the UK. When the Federal Reserve raised the US rate to a range from 0.5 to 0.75 percent in December 2016, sources told PERE “it’s a non-issue,” in part because, like the Bank of England’s decision, the increase was widely expected. In a report, M&G said in the US, “rising interest rates have so far not caused any major detrimental impact to US property yields,” though spreads between New York offices and 10-year treasury bonds have narrowed.
Both countries’ interest rates are still lower than historical averages.
“The impact of rising interest rates on real estate yields must be looked at in context,” said Eduardo Gorab, a research director with LaSalle Investment Management. He added that even a gradual increase in long-term government bond yields and subsequent pressure on property yields should be offset by overall rental growth. LaSalle’s forecast predicts property yields rising by 20 basis points by 2022, “a small move by historical standards,” Gorab told PERE.
By property type, Gorab said the picture “is much more mixed.” Risk-tolerant investors could take on some vacancy or development risk because rental growth should partially offset rising rates, particularly for in-demand property types such as industrial. Other investments that have not shown a correlation with movement in government bond yields, including non-London offices, also seem less exposed to rising rates, he said.
Global interest in UK real estate may also offset rising rates, said Richard Gwilliam, M&G’s head of property research. Cross-border entities have increased from about 64 percent of the UK buyer pool in 2014 to 71 percent in the year to date, according to data provider Real Capital Analytics. Indeed, only one UK-based firm, M7 Real Estate, ranked in the top 10 buyers of UK property in the last two years, per RCA.
“There is a healthy risk premium currently priced into UK property which can help to absorb higher interest rates, while increased global capital flows mean UK interest rates are arguably a less significant influence on property investment than previously,” Gwilliam said.
The UK’s central bank has one major hurdle to factor in with no precedent in the US, however: Brexit. Last week, Carney said the Bank of England wanted to act now, rather than wait for Brexit, for the interest rate increase. The Bank of England’s decision to raise rates last week was unanimous, but it also signaled it may not raise rates again with Brexit uncertainty.
“If there is a major shift as a consequence of the Brexit negotiations, that is dis-inflationary, or creates a very extreme trade-off, such as the one we saw post-referendum, then that could have consequences for monetary policy,” Carney said in a press conference. “There’s a wide range of Brexit outcomes, but in many of them, interest rates will be at least as high as they are today, so we don’t need to keep our powder dry for that. The mistake is to always wait, wait, wait, until you have perfect certainty because we don’t know when that higher degree of certainty is going to transpire.”