Global Perspectives

Rising Inflation, Higher Interest Rates, Quantitative Tightening: The Implications for Real Estate

Over the summer, we are taking a break from our World in 2022 series and revisiting the prospects for subsectors of the Private Capital market. This month we look at Real Estate.

High inflation, supply chain disruption, pandemic tail effects, tightening monetary policy and the War in Ukraine have given rise to a potent mix of factors disturbing the equilibrium of investment markets in the first half of 2022, with equities and bonds seeing substantial declines. Attention has turned to the potential impact on property prices around the World, with concerns being voiced over the historically high residential prices in some countries.

Recent research by Capital Economics indicates that price falls are already experienced in markets such as New Zealand and Canada, where valuations appear to be stretched. And there has been increased speculation about the combined effects of post-pandemic hybrid working and escalating borrowing costs on occupancy and demand in the commercial property market.

Whilst rising property prices may see some level of correction; it seems unlikely they will be up-ended by a reset of base lending rates nearer to long-term norms. Whilst substantial rate hikes are expected, at this point, leading commentators anticipate that US rates will not rise much beyond 4%, the UK 3% and the Euro area 2%. This scenario is contingent on Central banks acting to head off a hard landing by bringing inflation under control and obviating the need for more drastic measures.

Policy action could lead to a technical recession in some markets, and there is no doubt that risks have increased. Still, a cautious approach to asset target selection will be paramount.

In this respect, other categories of real estate with inflation-proofing characteristics will see support from yield-hungry investors such as pension funds, who are under considerable pressure to maintain the purchasing power of their member's pension pots as the cost-of -living crisis bites.

Blackstone's real estate arm is the most significant private sector player in the commercial real estate market. Founder Chair and CEO Stephen Schwarzman, and President and Chief Operating Officer Jon Gray, shared some telling insights at their first quarter 2022 investor call.

Another sector that has historically held up well in slower growth environments has been student accommodation. It has proven to be an attractive long-term investment hedge for real estate investors against both inflationary and recessionary environments, with student numbers tending to rise in periods of economic downturn. The recent sale of the Brookfield UK Student Roost portfolio to GIC and Greystar for more than £3bn would indicate there is still life in this strategy.

Of course, the risk of recession is tangible, and the astute real estate firm will already be weighing the increased risk very carefully. However, properties with shorter duration leases and good locations should continue to protect from the sticky inflation driven by wage demands and supply-side shortages. Unlike bonds, rental returns can increase, and upward pressure on construction costs may constrain new development, further supporting price levels, higher occupancies, and demand for existing assets.

Our own experience at Mourant is similarly positive for the first quarter but deal flow has naturally adjusted to recent events on the back of central bank policy tightening. We expect a quieter period over the summer as the interest rate cycle works through the system, but the quantum of investment interest is likely to be reignited once the policy tightening phase matures.

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Global Perspectives provides regular, on-point commentary on relevant topics in a pithy and accessible way. Our observations and points of view are based on listening hard to clients global needs, priorities and concerns. We draw on insights from every area of our business and collaborate to deliver this global thinking; something that clients tell us is distinctive and sets us apart.  If you'd like to find out more, please get in touch.