The Bank of England’s emergency interest rate cut on 11 March, much like that of the US Federal Reserve on 3 March, was designed to counter today’s immediate threat to economic stability: the spread of the coronavirus. However, it has also sent a clear signal to markets that the lower-for-longer interest rate environment will not be coming to an end any time soon.
The European Central Bank surprised markets on 12 March by not cutting rates, which are already in negative territory. However, its announcement of a new economic stimulus package to combat covid-19 similarly suggested that monetary policy will remain loose.
Little more than a year ago, the tide was turning against loose monetary policy. The Fed hiked rates four times in 2018 and, on the other side of the Atlantic, the ECB in December of that year announced an end to its bond-purchasing programme. The world, it seemed, was being weaned off cheap money.
But as global economic growth projections worsened during 2019, central bankers did an about-turn. The Fed cut rates three times in 2019 and last March the ECB unveiled a new stimulus package, meaning an end to negative rates in Europe became more remote. The threat of covid-19 has now convinced policymakers in the US and the UK to further lean on rates to protect their economies.
On the face of it, persistently low rates will benefit the commercial real estate industry in Europe, and those financing it. Low rates mean low yields from traditional investments like bonds and gilts, which push capital providers towards alternative sectors such as real estate. Borrowers benefit from cheap financing to support their property purchases. Those raising institutional capital for non-bank real estate lending strategies are more likely to attract investors’ attention.
However, as our sister title PERE explored in a recent Deep Dive analysis, although lower rates can boost real estate in the short term, their persistence creates longer-term uncertainty for equity and debt participants.
For a start, increased demand for property at this late stage in the cycle will keep prices high and yields low. This will make it difficult for those aiming to deploy new equity into the market to find viable opportunities. Sustained low rates typically lead to diminished returns in the long run. This has been seen across European markets in recent years, and the prospect of continued low rates is likely to mean further downward pressure.
As managers aim to boost returns, there is a danger some will turn to using higher leverage to hit their marks. This has yet to be seen on a widespread basis and the market does not appear to be overheating. However, some managers are absolutely edging up the risk curve in other ways, such as by taking on more development risk, investing in untested property types or entering non-core geographic markets. Lenders will be forced to consider which sponsors’ strategies they are comfortable financing.
Although alternative providers are a growing sub-set of the property lending industry, banks remain the market’s dominant group of debt providers. For them, ongoing low rates mean a further squeeze on profitability as they compete with each other to provide borrowers with cheap loans.
More generally, low rates indicate slow growth and economic instability, which ultimately impact real estate performance. There are fears of a global recession, heightened by the covid-19 crisis. And, with rates already close to, or below, zero, central bankers have limited monetary policy tools at their disposal.
Although historically low interest rates have created the conditions for a booming real estate market in the current cycle, the prospect of them remaining low for the foreseeable future is not altogether an attractive reality.
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