There are a number of factors influencing UK Commercial Property, all of which should be considered prior to any investment. Inflation and interest rates are likely to have a notable impact on the property market as a whole. In order to understand their impact on Commercial property, it is important to understand how they work.
Inflation can be defined as a general increase in the price of goods and services in an economy leading to a reduced purchasing power. This means that higher levels of inflation indicate that prices are rising at a higher rate and lower levels of inflation indicate that prices are rising at a slower rate. Inflation is a global force and affects almost every economy in the world. Inflation is a concern for governments and consumers as it gradually erodes purchasing power, contributing to an increased cost of living for consumers. If inflation is not carefully managed, it can contribute to an unstable macroeconomic environment and erode business confidence and decrease investment within the economy. On the other hand, low levels of inflation are actually beneficial for an economy. This is due to the fact that inflation can support economic growth by encouraging spending, supporting wage growth and avoiding deflation. In order to keep inflation at a manageable level, the Bank of England has set a target inflation of 2%. This inflation target of 2% is achieved using various Monetary Policy tools. Firstly, the Bank of England will adjust the Bank Rate. By adjusting the Bank Rate, the BoE can increase or decrease the cost of borrowing, encouraging spending or saving amongst consumers and impacting the overall demand within the economy. Lower rates are likely to stimulate borrowing and increase spending, which, in turn, will see an increase in inflationary pressures. Higher rates, on the other hand, are likely to increase the cost of borrowing and stimulate savings amongst consumers, this will, in turn, decrease inflationary pressures. Secondly, the Bank of England can inject money into the economy by buying government bonds or other financial assets. This is known as Quantitative Easing and can help stimulate spending and increase inflation. While there is an obvious link between interest rates and inflation, they have different impacts on commercial property in the UK.
Impacts of Inflation on Commercial Property:
As previously mentioned, there are a number of ways in which inflation impacts the commercial property market in the UK.
Increased Prices: Higher levels of inflation are likely to contribute to a significant increase in the costs associated with the development of commercial property. For example, the cost of construction, labour and materials generally increases with inflation, contributing to a higher overall development cost.
Operating Expenses: Operating costs such as maintenance, electricity and water are also impacted by inflationary pressures and are likely to increase with inflation.
Leases and Rents: Rentals generally increase every year. This increase will either be a fixed amount, or it will be linked to inflation (CPI). If it is linked to inflation, landlords will receive the same amount of rental, in real terms. If it is not linked to CPI, landlords may see a gradual erosion of their rental, in real terms.
Values: In the case where rising costs outpace real returns, there will be a reduction in the overall value of properties. On the other hand, where real returns outpace inflation, property owners will see an increase in their property values. The level of property values within an economy is an important indicator of the overall health of an economy.
Impacts of Interest Rates on Commercial Property:
Increased Cost of Borrowing: As interest rates increase, so too does the cost of borrowing. This will have a dampening effect on the property market as property investment and development becomes more expensive.
Investor Demand: As a result of increased interest rates, it will become more expensive for property investors to purchase property. This is likely to lead to a decrease in property investment as a result of the rising costs.
Economic Growth and Tenant Demand: An increase in interest rates is likely to dampen economic growth as the cost of borrowing rises and consumers are more incentivised to save. On the other hand, a decrease in interest rates can stimulate economic growth, enabling borrowers cheaper access to capital. In addition to this, decreased interest rates will incentivise consumers to spend their income as the reward for saving (interest) will decrease along with the interest rates.
In conclusion, there are various ways in which interest rates and inflation impact commercial property in the UK. With this in mind, it is important to understand these impacts prior to any investment in UK commercial property. The services of a mortgage broker can be vital in gaining a further understanding of the UK’s macroeconomic environment and its impact on commercial property. Mortgage brokers can leverage their industry experience to advise their clients.