Were Interest Rates Real-Estate Drivers In 2017?
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Interest rates continued to underpin property markets, which surprised as much as terrified observers. Nominal long-term government bond rates barely changed in the three-month period to 2 February 2018. As a matter of fact, the economically mature world is still a low-interest rate environment, with the exception of the US. Obviously, nominal long term interest rates are higher in emerging markets, for example Turkey and Brazil.
In the US, the Federal Open Market Committee raised the fed funds rate three times in 2017, by a quarter of a point each time, taking it to 1.5% on 13 December. The Fed raised its key rate to 1.25% on 14 June, only two months after lifting it to 1% in March. Ten-year US government bonds carried a yield of 2.78% as at 2 February 2018, which was still reasonable in absolute terms from a historical viewpoint, yet 45 basis points higher than at the end of 2017.
In Europe, both short- and long-term interest rates were (and are still) very low. On 14 December 2017, the Governing Council of the European Central Bank (ECB) decided to keep the main refinancing rate unchanged at 0% (source: ECB).
Even though short-term interest rates are set and changed by central banks, rather than by the ‘markets’, interestingly, market-dictated 10-year nominal rates stayed modest. To some extent, capital markets were distorted by these very low rates, with substantial liquidity channelled into different asset classes including real estate.
That is why we believe that capitalisation rates have been driven by liquidity (due to quantitative easing) rather than property fundamentals in the past.
More importantly, real long-term rates — adjusted for inflation — hovered at between 0% and -1% in 2017, or were outright negative. The UK is a good example. Annual headline inflation reached 3% in December 2017, turning 10-year real interest rates deeply negative. Actually, real rates matter more to property investors. Nominal interest rates can be ‘digested’ by real-estate investors because, in most countries, net rents are either (partially) indexed to core inflation or subject to upward rental revisions to compensate for inflationary erosion.
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