Investors: Operating in a higher interest rate environment
This article is part of JLL’s Global Real Estate Outlook 2023
For the past 15 years the direction of borrowing costs has been pretty much a one-way bet. With central bank policy rates pushed to near-zero across much of the world during the global financial crisis (GFC) and staying there for a decade, benchmark bond yields and other debt reference costs fell steadily. The policy response to Covid drove rates lower still and undid the limited tightening that had been seen in the years prior.
Central banks tighten further with potential to overshoot
We are now moving towards a higher interest rate environment. The next year or so will see most major central banks tighten monetary policy further, likely pushing through neutral into contractionary territory. This will be an overshoot, and as growth slows and inflation falls, rates will descend back down to neutral (which is neither stimulative nor contractionary on the economy).
We have become so used to cheap money that this adjustment is going to be a shock. But it is worth noting that we are not returning to pre-GFC rates. Economic actors have become far more interest-rate sensitive, meaning that a smaller base rate shift today will do the same as a bigger shift in the past, giving central banks ‘more bang for each quarter-point-adjustment buck’. The net result is that ‘neutral’ will be lower, although how low is unknown.
Uncertainty will persist into the first half of 2023
The key challenge for the commercial real estate industry is uncertainty over the size, speed and the duration of the adjustment. This uncertainty is weighing on real estate capital markets’ activity and will persist into the first half of 2023. There is still a significant amount of capital sitting on the sidelines, and as with any period of adjustment, investment opportunities will arise.
Two big unknowns are likely to remain through 2023 - China’s zero-Covid policy and the impact on global supply chains, and the war in Ukraine with the flow-through effects on commodity and energy prices. However, there are good reasons to expect other uncertainties to ease as the year evolves. Firstly, there is emerging evidence that inflation has peaked in the U.S. and potentially across Europe, and a further slowing is anticipated. Secondly, ebbing inflation has tempered expectations for central bank rate tightening, suggesting that reference rates will not rise as high – nor as fast – as even recently expected. Thirdly, there is light at the end of the tunnel on growth. A global recovery is looking like it will take shape by mid-year 2023 at the latest, though not evenly distributed.
High-growth sectors anticipated to see strong demand following temporary slowdown
As uncertainty is the biggest impediment to the real estate sector, its gradual easing will be undoubtedly positive. The volatility of debt costs will lessen, the current phase of price discovery will pass, and more certainty will enter the market as underwriting becomes clearer and appetite for risk returns. The period of repricing will see winners and losers, but forced sellers are expected to be limited.
High-growth sectors such as life sciences and data centers are anticipated to emerge from the temporary pause to strong demand as structural factors support occupational activity, while the Living sector is likely to prove relatively resilient throughout the downturn and beyond.
Overall, we forecast that the market will continue to adjust rapidly compared to previous downturns and there is an expectation for market liquidity to improve into the second half of 2023.