When will the real estate market get the interest rate cut it badly craves?

At the start of the year, the consensus expectation was that by now the Federal Reserve – the US central bank - would have just declared its first interest rate cut and that the Bank of England would follow suit. But pretty much everybody stopped expecting this in recent weeks, and the US Federal Reserve confirmed this shift in expectations was correct by deciding to keep rates on hold at its 20th March meeting - a decision that was mirrored by the Bank of England the following day.

As all of us working in the commercial property sector know, the significance of interest rates to real estate markets cannot be understated, a key reason being that the cost of finance – which so many real estate transactions and development projects rest on – is dictated by rates. When finance costs are high, demand for real estate declines and valuations fall, and property owners are more likely to default on their loans. Higher interest rates also tend to reduce the attractiveness of real estate investments when compared with other investments, such as bonds.

Phrases like ‘survive until 2025’ have been doing the rounds in property investment circles in recent months and are in a large part reference to a time in 2025 when rates will have fallen, enabling real estate markets to bounce back, lowering refinancing risks and spurring a recovery in valuations and new project starts. But as the first quarter of 2024 draws to a close with no rate cuts yet to speak of, you could be forgiven for asking, will rates really have come down by that much by 2025?

True, the Fed announced it expects to cut rates three times a year at its recent meeting but, as always, this will be data dependant. Global interest rate rises expected earlier this year were dialled back due to US inflation coming in higher than anticipated in February, combined with rising employment numbers.

In the UK, although the economy has likely tipped into recession, core inflation remains at around 5%, which means the Bank of England has to be cautious in its bid to fight inflation. Some experts also cite ‘the fear of going first’ – arguing that until the Fed begins cutting rates in the world’s largest economy, other European central banks are unlikely to start cutting. This means that if US economic data continues to come in stronger than expected, we could all be waiting longer for rate cuts.

What could this mean for real estate markets? Capital Economics sounded the alarm earlier this year saying USD 2.2 trillion of commercial real estate debt is set to mature between now and 2027 and will need to be refinanced. The higher interest rates are, the higher the cost of refinancing will be, and the more likely the market is to see waves of defaults and distressed asset sales at lower prices.

The flipside is that for well-capitalised property investors with the right skillset, this backdrop is creating opportunities to acquire well-located assets at discounted prices with the potential to add value through refurbishment or redevelopment. Some of our clients say they are seeing more high-quality commercial real estate starting to come to market across Europe, as building owners facing increasing pressure from higher financing costs and changing energy efficiency regulations decide to bring their properties to market at a discount now, when fewer buyers are around.

Although a higher-for-longer interest rate environment is painful for some property owners, for commercial real estate investors in the right position - with capital available and strong expertise - it is offering opportunities. Many believe now is the time to take advantage, position themselves for long-term success and benefit from rising real estate valuations that will materialise when rates are ultimately cut. Until then, the market looks set to be divided between those able to take advantage of the short-term opportunities higher interest rates are providing in certain parts of the market, and those that aren’t.