New world of higher rates and higher returns for real estate

Russia’s invasion of Ukraine, a year ago this week, may have marked the end of the low-rate, low-return environment that, since the 2008 global financial crisis, pushed trillions of dollars into real estate, depressed yields and led to record-high property prices, according to new research published yesterday by MSCI.

Tom Leahy, Head of EMEA Real Assets Research, MSCI

“It’s a new world of higher rates and higher returns,” said Tom Leahy, head of EMEA real assets research, MSCI. “The rapid rise in swap rates meant debt costs surged above property yields after years when a substantial gap had encouraged capital into the sector.”

The impact of rising interest rates was most acutely felt in Europe, and particularly in Germany, where the country’s reliance on Russian energy proved to be its Achilles heel. German property sales started to slow in April 2022, sank to a six-year low for the first half of the year and continued to fade through the rest of last year.

It did not just affect Germany: very few countries escaped the slowdown, as buyer and seller price expectations moved apart, leading to a substantial drop in liquidity. Global transaction volumes were down 64% in the fourth quarter.

Chart shows basis-point spread and office yields to 10-year government bonds. Source: RCA Hedonic Series office yields

In the short term, further easing in inflation, plus stability in bond yields and debt costs, would provide a degree of security and give buyers and sellers more solid ground on which to make their buy-sell-hold decisions. 

“Once past this shorter-term disruption, the question is where real estate fits into a remodelled investment landscape,” said Leahy. “Core property effectively acted as a bond substitute during the low-rate regime, but interest rates and bond yields will likely settle at a higher level than during the last cycle. This means property may serve a different purpose in a multi-asset-class context.”