Inflation and its impact on property and asset classes

High inflation has become a global economic issue since Q4 2021 with Government stimulus packages driving the post-COVID economic recovery, producing a surge in demand for goods while supply chains remain disrupted. Russia's war in Ukraine further fans the flames of inflation.

As of March 2022, the inflation rate in the European Union was 7.8 percent, with Germany recording a rate of 7.6 percent and France 5.1 percent. The UK hit 7 percent in March. The current rate of inflation in the EU is highest since the previous peak in July 2008 when prices were growing by 4.4 percent year-on-year. However, between 2012 – 2021 inflation was on average below 3 percent. Besides, and due to increasing costs for consumers such as rising food and energy prices, interest rates have started to rise. Credit markets reacted by increasing lending margins on business loans, including real estate lending.

Finloop's Chief Operating Officer, Dr Nicole Lux, comments, while interest rates are still modest compared to historic levels, and property yields are at historically low levels in some sectors. Thus, even a small increase in overall interest rates will result in unsustainable ICR (interest-coverage ratio) levels for sectors, such as logistics or prime office and could lead to payment defaults. Following FinLoop's analysis, Dr Lux said we find that the interest rate shift, which is already reflected in rising government bond yields and in higher financing costs, has not yet affected the real estate market, nor has it been priced in

FinLoop's analysis of ICRs for different property sectors shows that when loan margins rise by 100 basis point, some sectors we be close to 1.1 x ICR levels. During Q1 2022 increases of 50 – 70bps were already reported across lenders, leaving the average lending rate for UK prime offices in the key cities at 2.2 – 2.5 percent (55 percent LTV) and for Germany at 1.8 - 2 percent albeit at slightly higher LTV on average (60 percent LTV). (Download the full presentation below)

These conclusions were shared during a webinar on the topic held on 31st May, 1pm CET. Speakers also included Innes McFee, an economist of Oxford Economics, Hans Vrensen, Real Estate Strategy & Research at AEW, a fund manager, and Thomas Beyerle, Research at Catella Valuations, an advisory firm. The webinar was chaired by Cléo Folkes of Property Overview. The recording of this webinar will be made available on the FinLoop website shortly.

Thomas Beyerle's, Managing Director, Catella Property Valuation GmbH commented: It is becoming clear that the zero interest rate phase in the European currency area is coming to an end. This puts pressure on the mantra "real estate is an inflation hedge". However, I believe that the first interest rate steps in the eurozone will have more of a psychological effect than a real, measurable one on real estate yields.

Innes McFee, Managing Director & Economist, Oxford Economics added: We expect European inflation to peak this year as the impact of food and energy price shocks and new supply bottlenecks feed into the numbers. But the key question for real estate returns is actually about the impact that high inflation and monetary policy tightening will have on growth. In our view the impetus from reopening of the service sector will help to keep Europe out of recession albeit the risks of a shallow but prolonged downturn are high.