Interest rates & asset pricing

Interest rate trajectory set to shape recovery in real estate transactions and asset values

Clarity across markets has been in short supply amid the rapid rise in interest rates, a critical factor in property investment underwriting and asset valuations. Starting in March 2022, the Federal Reserve has raised its key interest rate at the fastest pace since the 1980s in order to tame inflation. Other central banks followed suit, resulting in significant dislocation across real estate capital markets.

Towards the end of 2023, central banks’ progress in stemming inflation has become evident. This has led to the sentiment among investors that interest rates are likely at their peak. But given the resilience of many economies globally, interest rates are expected to stay elevated well into 2024.

The stability and predictability of rates hold more significance to the improvement in market activity than borrowing costs alone. Stable interest rates will mean the return of predictability to debt costs, and with future policy rate movements likely to be downward, this means future borrowing costs will fall. Some respite is on the horizon, with financial markets pricing in the falling future policy rates, with the yield on 10-year Treasuries below the Fed Funds rate. The same is true for comparable metrics in the UK and Eurozone.

Asset pricing stands to improve following sustained stability in index rates

As interest rates and capital costs rose, bid-ask spreads in commercial real estate (CRE) markets widened, leading to a drop in transaction volumes. Sentiment that interest rates are now peaking will help stabilize pricing, but it will take time and prolonged stability in index rates to further unlock the dry powder and investment strategies that have been building on the side-lines. On the other hand, if volatility in benchmark indices persists, or recessionary risk worsens, it will impact the duration and extent of current pricing volatility and the timing of a market recovery.

Consensus indicates that rates will stabilize above the lows seen after the Global Financial Crisis and in the COVID-19 era. Rate cuts are expected to begin by the second half of 2024, bar Japan and China, where monetary policies have varied from other major economies. This should help lead to increased loan originations in 2024, and transactions will provide clearer data points on property values for lenders, investors and valuers.

Real estate has already seen a growing number of bidders re-enter the market since late-2022 levels, according to JLL’s proprietary Bid Intensity Index. The improvement has been supported in particular by bidding activity from private investors, as well as select institutional players, such as sovereign wealth funds and higher-yielding separate accounts.

The reset in values will both challenge capital and catalyze liquidity. The US is furthest along in its price adjustment cycle, followed by Europe and then Asia Pacific. There remains variability in pricing dynamics globally outside of the US. Of the larger markets, the UK and Australia have seen pricing recalibrate to a greater extent than Germany and France through 2023, supporting price discovery albeit on constrained investment volumes. Japan remains a competitive market where pricing has held firm, supported by resilient domestic and cross-border investors. Existing funds and portfolios that benefitted from appreciating values during the past decade will face winning and losing strategies, while dry powder and new strategies will be afforded opportunities.