Major central banks such as the European Central Bank and the Bank of England have started cutting interest rates in recent months, and the US Federal Reserve is expected to follow suit as early as next month. However, one capital markets manager does not believe such cuts will have a major impact on property prices.
“There is a lot of talk about interest rates and how when interest rates fall, prices improve and demand increases,” says Stephen Down, head of the Central London and international investment team at London-based real estate services provider Savills. “Personally, I have been around for decades and I believe that interest rate cuts do not necessarily lead to better prices. I think prices will stabilise at levels we have not seen for over 15 years. To get the institutional money back, you have to pay a premium, at least in the short term.”
“If (pricing) is only correlated with leverage, then I think we’re looking at something that’s not going to happen,” he adds. “I disagree with those who say, ‘Give me another 25 basis point improvement in leverage and I’ll see another 25 basis point improvement in net yield.'”
Down cautioned against expecting yield compression to be imminent. “I would say it’s all about growth,” he notes. “It’s about income yield, and hence the rental growth story, that’s your income yield. The majority of your future return should come from income growth, not capital appreciation through yield compression.”
Still, “we would like to see a slight increase in earnings,” says Down. “But I just don’t think it will add as much value as some might think.”
History of rental growth
In the London office sector, “rent growth is supporting values more than it was a year ago or six months ago,” he says. But “I think this year sales in London will still be very subdued. We are in the middle of the year. We have barely reached 3 billion pounds (3.97 billion dollars; 3.56 billion euros). Five or six years ago we were now well over 10 to 12 billion pounds.”
In the first half of 2024, European office investment transactions totaled €14.1 billion, down 21 percent from the same period last year and down 60 percent from the five-year average of €36 billion. The United Kingdom continued to dominate activity, accounting for 29 percent of European office investment volumes, above its five-year average of 24 percent, reflecting faster initial price adjustment and attractive yields for cash buyers in the country.
“If we didn’t have rental growth behind us, I don’t think we would even be reaching the levels we are,” adds Down. “Rental growth in London is definitely a major catalyst.”
In London’s West End, average monthly office rents in prime locations have risen from £134.41 per square metre last year to £137.25 this year and are expected to reach £158.75 by 2028, according to Savills data. In the City, these rents have risen from £90.64 per square metre last year to £95.25 this year and are expected to rise to £111 by 2028, according to Savills data.
In fact, the City’s forecast average rental growth of 4.1 per cent for 2024-28 is higher than the 15-year average of 3.4 per cent, according to Savills data. However, in the West End, the forecast average rental growth for the same period is 3.4 per cent, below the 15-year average of 4 per cent.
Despite expectations that much investment capital would be focused on core or core-plus assets in this early phase of the recovery, most of the money has been invested in riskier but higher-yielding assets, Down notes. Investors are increasingly willing to deploy capital in refurbished assets that can benefit from rental growth over the next two to four years before new-build supply meets demand, he says.
“That explains why the private equity market is busier than we might expect in this early phase of the recovery,” Down continues. “We’ve seen Blackstone come back into the market, particularly in London… They never left, but it’s just been quieter over the last 18 months than we’re used to. And then others from the US are bidding on situations.”
