di Thomas Beyerle, Managing Director IVG Immobilien AG, Head of Corporate Sustainability & Research
Today we will present a topic that represents an essential component of real estate investment DNA. What we are talking about is interest – specifically, the effects of changes in interest rates on property markets. The fact that rising interest rates can potentially pose an enormous risk to the global capital markets is reflected in the Fed’s cautious announcement in June that it might reduce its extensive bond purchases. As a result, share and bond indices – particularly in emerging markets – slumped by as much as 20% in some cases.
Nonetheless, we must be aware that the asset class of property in particular owes has owed its boom times since 2009 to the low-interest policy. This will also continue. If there is consequently an increase in base rates, what kind of reactions can we expect then?
With regard to the real estate investment markets, there has so far been no indication that initial yields for very good properties in the strong European markets could increase. For roughly a year, these yields have been at a level just above that of the pre-crisis years.
For two reasons, we rate the risk of rising interest rates for the property market as limited, at least for the next few years.
- Firstly, interest rates are likely to increase only very slowly. The lack of a foreseeable end to the weak development of the real economy, the restructuring of the banking industry and the continued fragile construction of the Eurozone for the foreseeable future, accompanied by low inflation, mean that no major upward pressure on interest rates can be identified. In the long term, however, when the European economy returns to normal, a departure from the policy of cheap money can be expected, meaning considerably higher interest rates. But for the time being it is not clear when this effect, i.e. the change in interest rates, will begin.
- Secondly, our models show that interest rates do not have a significant effect on top yields in all markets, whereas the development on the rental markets plays a much greater role across the board. At least for the top segment in many core European markets, this development can be rated as relatively good and is also likely to improve further, particularly due to the substantial decrease in completions.
Overall, there are therefore good reasons for us to assume that the low level of top yields in the Western and Eastern European office centres will continue, while in the crisis-ridden markets of Europe’s peripheral regions a gradual decline in top yields can be expected.
However, for the current locations characterised by low initial yields, this also means that in the coming years total returns are generally likely to be weak in absolute terms, although the performance relative to government bonds should be acceptable.