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Beware rising discount rates — they are going to mean lower returns for commercial real estate, according to new analysis by Oxford Economics.
The expectation of higher policy interest rates peaking this year “present a challenging environment for underwriting long-duration investments such as commercial real estate,” Oxford said. The result will be higher discount rates and risk premiums, which could hit the profitability of real estate investment.
Oxford Economics concluded that the combined impact of higher risk-free interest rates and a higher risk premium is a present value of investments that could be 8%-12% lower for the eurozone, UK and U.S.
The consultancy bases its calculations on inflation in the eurozone, UK and U.S. falling back rapidly in 2023 as supply chain bottlenecks ease. It expects it to reach 3.4% and 4.5% by year-end in the U.S. and UK.
This should allow advanced economy policy rates to peak this year before converging with the neutral rate, by which they mean the point at which monetary policy isn't seriously making much difference to interest rates by being too loose or too restrictive. The firm expects to see this by 2025.
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