The Bank of England didn’t raise the UK base rate in May. However, the forward guidance remains that rates need to ‘normalise’.

There is a perceived relationship between base rates and property yields, yet to understand the influence of any such movement and pricing on London’s property market you have to decipher the differences between prime and secondary.

Prime

A rise in interest rates in the UK is unlikely to have an immediate impact on London’s prime commercial property market. Examining the relationship between City office yields and the base rate since 1990, reveals that the two only grew in tandem in two out of the five periods when the base rate rose.

The globalisation of demand for London has played its role. 62 per cent of the £237 billion invested in London offices since 2009 has come from non-domestic sources, with a focus on prime. These investors’ motivations for buying are slightly different to those of domestic investors. With many of them equity backed, income security can be more important than rental growth prospects, and comparative risk and return to their local market is as important as pricing in the destination.

Secondary

In secondary, we may see a change where buyers are more highly leveraged, values are more exposed and international interest decreases. A hike (albeit an excessive one) has the potential to ‘weaken the weak’.

Boosted by overseas investors making a currency play since 2016, the weight of demand for London has not only seen record breaking prices for trophy assets, but non-core assets, in many cases, achieved core pricing. This was never sustainable and, by the second half of 2017, various sales that were classed as ‘core plus’/‘opportunistic’, but priced as core, failed.

There’s tentative evidence that London has normalised in 2018, with a greater polarisation between the prime/core assets that investors want and those they don’t.  A rise in rates could exaggerate this divide further and pricing on secondary assets could drive a very modest softening of values.

Hedging

The level of interest rates in the target country will certainly impact the direction of investment flows so far as hedging costs are concerned. The high level of hedging costs in the US and the relatively low level in Europe means that today many investors rank Europe first in attractiveness, UK second and US third.

Returns on offices

Returns on global real estate continue to look attractive compared with other assets. Last year, UK offices delivered an average return of 8.5 per cent when UK 10-year gilts only offered 2.6 per cent. London’s low office vacancy rate (4.9 per cent), far beneath the point normally expected at this stage of the cycle, and consistently strong rental levels continue to offer investors attractive market fundamentals.

With our time zone, currency, leasing structure, market transparency and language (and despite Brexit, a hesitant business community and weaker growth in the wider UK economy), London remains a powerful and attractive draw for global capital.

Further information

Read more: Demand buoyant but lack of stock hampers Q1 central London investment activity