In this latest blog, Coverdale Barclay’s account director Alexander Peel, offers an overview of the importance of interest rates to the real estate sector – and argues that while many of the factors affecting rates are out of the control of the current government, there are reasons to suggest October’s budget could result in the ‘cutting cycle’ being quicker than expected.
Trying to forecast precisely where interest rates are heading is a little like trying to predict England’s fortunes in a major football tournament. You may have the data to back up your thesis, but you will want to hedge your bets – because things never quite turn out the way you’ve planned.
Those in the property world know this all too well. In fact, you could argue that much of the financial difficulty facing certain companies after the Bank of England began its rate-rising campaign in 2022 stemmed from the fact they became too comfortable with the rock-bottom interest rate environment that had endured for more than a decade. Money was cheap, and it was easy to build – until it wasn’t.
Interest rates have a profound impact on many sectors of the economy, but real estate bears one of the more direct relationships. Developments are typically funded through a mix of debt and equity, and so higher borrowing costs mean building is more expensive – in turn meaning developers need to secure higher yields to remain profitable. This can influence the relative popularity of different sectors, as investors seek out the most resilient and profitable asset types.
Higher rates also dampen demand, most immediately for housebuilders. Expensive mortgages mean fewer people are able to buy homes from the companies that are building them. For this reason, in the public markets, the stock prices of volume housebuilders are some of the most sensitive to changes in interest rates, as well as the data that influences the Bank of England’s decision- making, such as inflation and labour market figures.
Finally, interest rates have a run-on effect on property values. Not just in the housing market – where as above, lower demand pushes prices down. But also for commercial property, where the prospect of high refinancing costs and lower yields makes the prospect of purchasing, for example, a central London office block, far less attractive. This is partly why the market has seen such drastic write downs in the value of these buildings in the recent past.
This is all to say that in the world of real estate, interest rates are a closely-watched thing. And a new government, with a new legislative agenda, and new approach to economic policy, has again raised questions about the direction of the UK’s monetary policy – even if it does not control it directly.
The first cut from the 15-year high of 5.25 percent came at the end of July, and was the result of an extremely close vote of five to four in the Bank of England’s Monetary Policy Committee (MPC). So it’s not entirely clear who is winning out between the bank’s ‘hawks’ (who would like to keep rates higher for longer) and ‘doves’ (who advocate for further cuts).
But committee members continue to be led by a few key indicators. Medium-term trends in pay and inflation, which Keir Starmer’s government unfortunately cannot take credit for, suggest a cycle of gradual easing. Inflation has reduced from an eye-watering 11.1 percent to right on the Bank of England’s two percent target.
Equally, the European Central Bank has continued to cut rates, and the US Federal Reserve will likely begin imminently, which will be reassuring for MPC members who do not want to remain an international outlier.
The government’s upcoming October budget – described by the Prime Minister as “painful” – will likely result in higher taxes for households, thus lower spending power, and ultimately a more difficult path towards increasing economic growth. A loose monetary policy, with lower interest rates, is one way to balance this – or at least dull some of the pain.
This is perhaps the most direct way the new government will affect where interest rates are headed.
Others, including analysts at Oxford Economics, agree that the cutting ‘cycle’ could be much quicker than anticipated, citing additional factors such as the lagging effect of monetary policy (due in large part to the increasing popularity of fixed rate mortgages) and overall uncertainty about the ‘neutral’ interest rate (at which monetary policy is supposedly not affecting growth). They suggest that rates could fall to as low as 3.25 percent within a year.
This will be welcome news to many in the real estate industry. But much like England’s football team, I would be reluctant to put any money on it.
