The economy and interest rates

High interests

Interest rates are now at their highest level for over 5 years. The rise in January was unexpected, and the justification for the increase was well documented, with inflation the main concern.

However how have these interest rate rises affected the commercial property market, and will the present level change the attitude of occupiers and investors, who fundamentally drive the commercial property market. Strong tenant demand for a particular property in a certain location, will generally lead to strong investor demand for that premises. This is based off the assumption that the property will be readily relettable at the end of the tenancy. In tandem with the importance of location, investors also look at the financial strength of the occupier. There is a need to ensure that the tenant can pay the rent for the period of the lease. A majority of property purchases are debt financed and therefore the increase in interest rates should have an effect on the demand for opportunities, but from recent transactions, this does not appear to be the case.

The most recent results from the London auction houses would suggest that demand for commercial investments remain unabated with yields remaining close to the levels seen over he last two years. The move in interest rates has not resulted in a corresponding shift in property yields. The main reason for this is that supply still out strips demand for prime property. In addition the occupational market is strong in certain areas, and again with the demand up on supply, this is leading to rental growth, which provides investors with the ability to improve on their yield, with reversionary rents; that is rents which are likely to increase. Prime properties with good quality occupiers seem to be unaffected by recent events.

It is however in the sub-prime market that the increased cost of debt financing is most likely to result in an increase in property yields. Where investors are purchasing property with debt, and where the cost of servicing this has increased there is a smaller cushion between income and repayments. With this smaller cushion comes a smaller revenue reserve for void periods and consequentially investors are cautious about the properties they purchase.

The occupational market appears to be unaffected by the increase in interest results, mainly due to the fact that cost of money is only one part of the equation which goes into running a business. Demand for owner occupied properties remains as strong, with pensions still a prime factor in driving this forward. The capital market (that is the investor lead market) for prime properties is strong, with sub-prime showing some slow down, but not as great as anticipated. Property which is tangible remains an important commodity for many and with development land in short supply, this inevitably leads to a shortage of suitable properties, pushing up prices, especially in the freehold market where owners are reluctant to sell. Supply and demand appear to drive the market, more than the cost of money.

Sam Kingston

Date Added: March 1st 2007