We have seen this movie before: monetary tightening leading to recession and then monetary easing.
The blockbuster version starred former US Federal Reserve chairman Alan Greenspan and played out over the noughties, leading to the global financial crisis (GFC) followed by 12 years of extremely loose fiscal policy.
We are potentially at the turning point of the current remake, and the language being used by central bankers at the end of 2022 became more dovish. The UK (and probably the eurozone) are already in recession, and with that backdrop, inflation is likely to start to recede, as it is already in the US. The direction of travel for the price of oil, which has dropped about $40 (£34) a barrel since June, is a fair indicator of both inflation and demand. While oil prices will fluctuate due to the war in Ukraine, the trend is very much down, with a medium-term target (by mid-2023) close to $60 (£50), as western-world demand reduces due to the likely long, albeit shallow, recession we are about to experience.
On that basis, we could be closer to peak interest rates in the UK – the consensus now seems to be an absolute peak of between 3.5% and 4% – with the possibility that the Bank of England will reduce UK interest rates from Q3 this year.
The shallow recession and resultant impact on interest rates will have an interesting effect on the UK and European real estate markets. We are entering an era where the creation of new real estate supply will be limited due to the lack of development finance, increasing construction costs, planning restrictions and the impact of embodied carbon. The relatively quick reversal of monetary policy by central banks is likely to prevent a major reversal in real estate markets.
Limited impact
There is no doubt that if you want to sell a property today, the price could be discounted by up to 20% against peak Q1 2022 valuations. But few groups are forced sellers, as much of the debt in the market is either swapped or capped. Investors’ hedging positions have value, which offsets capital losses, but more importantly it means that for much of the market, interest rate rises have not actually had much of an impact yet. Should rates fall, the hike will have bypassed much of the market.
Having said that, some investors are experiencing distress, namely those facing refinancing or losses elsewhere in their portfolio. The difference between 2008 and this market is that during the GFC, there was a general liquidity shortage, exacerbated by the hedging of interest rate positions – the very reverse of what we see today. Currently, there is no liquidity crisis (due to quantitative easing and there being plenty of equity on the sidelines), although there is some specific investor distress.
Turning to a specific opportunity in this market, I am firmly of the view that the office is not dead – far from it. What has changed is the lack of desire for a long-distance, mass-transit commute, so the mantra will, in part, move towards working near home rather than from home.
Despite current headwinds, the lack of new property supply will ensure that for the right product, there will more than likely be rental growth, as the ESG credentials of buildings become more stringent and the market faces a reduction in supply caused by obsolescence or use conversion. Indeed, the conversion of ‘brown’ offices to ‘green’ ones will be one of the most interesting plays of the next cycle.
Richard Croft is executive chairman of M7 Real Estate
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