Four key factors are confronting real estate investors who are proceeding through a "very different environment" from the one they have become accustomed to in recent years, according to Avison Young's chief economist Dr. Nick Axford.
"Overall, there is no question we will see upward pressure on real estate yields, which means downward pressure on pricing for commercial property," Axford said in a recent post.
Avison Young's factors include rising government bond yields; higher interest rates; rising costs to finance; and increasing materials costs combined with a tight labor market.
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US government bond yields have gone from around 2.9% at the start of this year to 5% today. "This increase of 210 bps is broadly the same as the 225 bps increase in the policy rate, suggesting that investors are not particularly concerned that we will see an increase in corporate failure – but highlighting that higher interest rates have a material impact on pricing across the spectrum of investment assets," the post states.
"These are the benchmarks against which real estate investments are priced, which will put upward pressure on yields (and downward pressure on values) in the property sector," Axford said.
Higher Interest Rates Put Pause on Investing
He said that higher interest rates are designed to slow the economy, which opens opportunities for investors looking for rental growth from shifts in occupational dynamics such as remote office working. "But short term, the weaker economic outlook reduces the prospects for rental growth in some areas of the market, which also hits investor sentiment and pricing."
As for the cost of financing, "Just as with homeowners, higher commercial borrowing costs make it harder for leveraged investors to justify current prices, and forces some buyers out of the market altogether," he says.
Materials costs are not only higher than they were six months ago but are quite unstable. Added to rising labor costs, it's difficult for companies to bid and evaluate bids, which might be good for only "a week or two," Axford said.
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