Impact of interest rate hikes in real estate. What’s in stake?
As Central Banks implement interest rate hikes, it is crucial to understand their primary objective: reducing inflation. Inflation refers to the widespread increase in prices of goods in markets, and when it surpasses 2% (a threshold set by the European Central Bank and the Federal Reserve), measures need to be taken to prevent it from spiraling out of control and becoming a persistent problem. Recently, the ECB decided to increase interest rates by 0.25%, bringing them to 4%. Let’s now focus on the impact these rate hikes have upon the real estate sector:
Increased cost of borrowing:
One crucial factor with significant implications is the increasing cost of borrowing, which can impede investors’ ability to acquire properties. Given that real estate assets are frequently financed through debt to increase returns, higher interest rates can decelerate real estate transactions. Consequently, planning for a refinance in the future for deals which make sense now might turn out as the safest bet for investors. All in all, properties with high cap rates and those which can cover interest rate spreads will be preferred to weather current interest-rate fluctuations.
Declines on real estate asset prices:
Interest rate hikes have a significant effect on decreasing asset prices, as demand is reduced due to the increased cost of credit. Potential investors may postpone or forego property acquisitions due to the higher costs associated with loans. As a result, there may be an oversupply in the real estate market, putting downward pressure on prices. In this case, we can also observe significant opportunities, with price corrections prevalent already in certain markets, evidencing an exceptional time to acquire assets at a substantial discount.
Limited investment in real estate development projects:
Interest rate hikes may restrict investment in large-scale developments. Developers and promoters relying on financing for construction projects may find fewer incentives to carry out these endeavors. Increased borrowing costs can make projects less profitable or tighten profit margins. Therefore, we may witness a shift towards assets that are considered less capital-intensive, resulting in a reduction in new-build supply, potentially affecting the growth and dynamics of the construction sector. As a result, we may likely see Core or Core+ strategies grow, as CAPEX- constraint investments become more appealing to investors.