Rising interest rates derail property recovery as buyers recut deals

Rising interest rates are derailing the fragile recovery in global commercial real estate, forcing buyers and sellers to reprice or abandon deals agreed only months ago. Property transaction volumes were expected to rebound this year after a lacklustre period following the sharp rate increases of 2022, but surging bond yields, driven by inflation from the conflict in the Middle East, have upended those expectations. Benchmark borrowing costs for the global economy have reached their highest levels since the 2000s.

Real estate is unusually sensitive to moves in long-term bond yields because development is heavily debt-financed, with financing costs rising in tandem. The value of property assets has a close inverse relationship with interest rates. Ten-year US Treasury yields have climbed above 5.3 per cent, up from about 4 per cent at the end of February, reaching their highest level since 2002. The yield on 10-year gilts has touched 5.53 per cent, the highest since 2007.

The result is that buyers are seeking to recut deals struck over the summer. Several investors are negotiating for price cuts in the single digits. One firm is seeking a 5 per cent discount on a $100 million deal for an industrial asset agreed three months ago. The pressure extends to smaller transactions: in a recent sale of a UK warehouse, second-round bids came in lower than the first round, according to a person familiar with the process.

“Anyone who went under offer over the summer and needs debt to get the deal done is now trying to renegotiate,” said David Turner, co-founder of real estate adviser DTRE. “A lot of our clients are asking for price chips. That leads to some difficult decisions for vendors.”

Ronald Dickerman, president of investment firm Madison International Realty, put the logic plainly: “The only logical conclusion is that real estate values have to fall.” If a buyer entered a contract three months ago and interest rates have backed up by 85 basis points, he asked, would that buyer not be concerned about the purchase price?

The mood at an industry conference in Munich this month was described as “dire” by one real estate investment banker. “People are seriously down in the mouth about what’s going on. Everyone’s got their heads in their hands a bit. It’s a matter of when and not if deals fall apart.” The banker added that new deals are simply not being launched. “Nobody launches into the teeth of this.”

The situation invites comparison with 2022, when rates rose sharply after the war in Ukraine and the turmoil of the UK’s “mini” Budget, sparking a painful market correction as property prices fell. But executives express concern that this time there are no near-term answers to the problems plaguing the global economy.

The pain is visible across the sector. UK office construction starts are hovering close to their lowest point in 15 years on a rolling annual basis. Charlie Green, chief executive of flexible office landlord Workspace, warned that a series of asset disposals would “likely take more time” due to higher interest rates and buyers making what the company believed to be subpar offers. “We are disciplined sellers and will only pursue sales at prices we believe would maximise shareholder value,” he said.

There are mitigating factors. The industry expects robust