Richard Williams, Investment Week, 30 September 2022:
The sharp interest rate rises expected to follow the collapse in the value of the pound do not bode well for the real estate sector in the UK.
Many of the REITs were already trading on large discounts to net asset value (NAV), in part due to the expected impact of rising interest rates on real estate values. Discounts have widened further in the past week as the pound weakened after chancellor Kwasi Kwarteng’s Mini Budget – raising the prospect of a faster and higher rise in interest rates by the Bank of England, and a deeper recession that could potentially affect demand for space by tenants.
The Bank of England raised interest rates by 50 basis points last week, and there was an expectation it could hold an emergency meeting as early as this week which would see rates rise by an additional 75 to 100 basis points.
Concerns caused shares in all UK companies to fall, with real estate particularly hard hit. The EPRA UK REIT index fell 8% between Thursday (22 September) and Monday (26 September).
Some REITs have been scrambling around to fix the rate on their debt to protect earnings being eroded by increasing interest costs. Real estate values are certain to fall as the higher cost of borrowing is factored into investors’ return projections.
With UK government bonds currently at a 4.6% yield, investors will baulk at the yield on offer in some real estate sectors, like logistics where yields on prime assets had been reported to have fallen below 3.5%.
A softening of yields and capital values is inevitable then. The pass-through from interest rates to property yields will not be one-for-one, with the latter being less volatile. However, if REITs are to make strong returns over the next few years, they are going to have to do it the old-fashioned way – by delivering material income growth…
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