Despite moderating inflation, interest rates are expected to remain elevated


The year is not shaping up to be what many investors were expecting.

Before summer, interest rates were viewed as likely to start coming down by the end of the year. Now, further rate hikes, while not necessarily likely, are not entirely ruled out in the second half of the year from the Federal Reserve, European Central Bank and Bank of England.

“Volatility remains, and it’s that alongside the mixed economic data that’s causing shifts to the rate outlook,” says Sean Coghlan, Global Head of Research & Strategy, Capital Markets at JLL. “The fluid economic climate continues to shape central bank policies, which are now expected to hold rates higher for longer to combat inflation.”

The tightening of monetary policy is continuing apace. The Federal Reserve in July raised its key benchmark rate to its highest level in more than 22 years. The European Central Bank increased interest rates by 25 basis points to 3.75%, as did the Bank of England, to 5.25%.

In commercial real estate, this means investors facing higher costs of capital are transacting less and fundraising is more challenging.

“As we move into the second half of 2023, expectations for the capital markets have been tempered,” says Coghlan.

The pathway to market recovery is anticipated to be uneven given bifurcated sector and market performance around the world, he adds. “However, as we navigate the latter half of the year, a semblance of predictability is re-emerging in fundamentals.”

Declines, but bright spots

Global direct investment in real estate fell 54% to $276 billion in the first half of 2023, the lowest level of first-half direct investment in a decade, according to JLL data. Such declines were seen in most markets globally. It was only Japan, with its more accretive rate and currency environment, that bucked the trend.

However, higher interest rates haven’t been affecting all real estate sectors the same. The logistics and living sectors, for instance, have been more resilient, buoyed by strong outlooks.

Another concern, especially in the U.S., was banks’ risk to loan exposure. Part of this has stemmed from multiple bank failures earlier in the year. But so far loan exposure isn’t expected to lead to systemic risk, Coghlan says. In the U.S., CRE loans only represent 23% of U.S. banks’ overall loan portfolios.

“Volatility in financial markets, as well as distress in the banking sector earlier in the year, continue to be monitored closely,” he says. “However, contagion to other markets has been minimal.”

Higher but not rising

With inflation figures above central bank targets in major markets like the U.S. and U.K., rates will remain elevated, but it’s unlikely that rates will rise much further.

In the U.K., inflation in June was 7.9%, coming in under analyst predictions for 8.2%. This means “the likelihood that bank base rates will have to rise significantly have started to recede,” says Marcus Dixon, director of U.K. Residential Research at JLL. “Further falls in inflation, as the impact of higher food and energy costs fall out of the figures, are also expected in the coming months.”

The more favorable outlook for where U.K. rates will top out is already leading to lenders reducing their mortgage rates, Dixon says.

Debt markets globally as a whole have remained relatively stable, and the availability of credit is solid, despite higher rates, Coghlan says.

“A breadth of lenders is deploying into multiple asset classes, although lender conviction is varied and strongest for logistics and living assets,” he says.