The inevitable rise of financing costs

After a long period of low interest rates the US and, last week, the UK have flagged interest rate rises. I have talked in previous blogs (Rational Exuberance and When spending your money is the challenge) about the UK real estate market sensitivity to interest rates rises. So what is the impact of a forecast future rise?

 

In fact to a large extent the rise in base rates at the end of this year, projected by Mark Carney, is already priced into the yield curve, so there has been a relatively modest rise in swap rates since their low point earlier in the year.

 

It is worth highlighting, however, that real estate borrowers have recently benefitted from something of a perfect storm for financing costs, If you look at the total funding cost, margin plus underlying swap, they have both been at unusually low levels for the last 18 months. Economic fundamentals would normally pull them in different directions, if margins are low swap costs are high and vice versa. For example pre crunch margins on real estate loans were frequently below 1%, but swap costs were high. Margins rocketed after the crunch, but this was off-set by the swap rate fall. Recently, however, there has been a strong supply of real estate lending driving down margins, whilst a relatively low growth, low inflation macro environment continued to suppress the swap curve.

 

A lot of the commentary in the last week has been advising borrowers to lock into long-term interest fixes whilst they are still low. The logical problem with this argument is that the swap rate already prices in the market's view of the expected rise. However, I think there is a good argument to say all in funding costs will rise whether growth and inflation are higher or lower than current expectations. What we don’t know is whether the rise will be on the margin or underlying rate.

 

An investment grade, real estate business can still borrow long term money at very low rates (15 years at c4% all in). Time to lock in if you haven't already?

Simon Hampton | Real Estate Deals Leader
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