Patience – the base interest rate will increase the value of commercial real estate | Business

This is definitely affecting our commercial real estate (CPR) values, just not as dramatically as it might seem. After all, by reducing base interest rates, the ECB increases investors’ appetite for debt, and at the same time, their tolerance for higher prices.

I often get a question regarding how the value of all commercial real estate will rise as a result of the ECB starting to lower the base interest rate, as the debt burden on real estate will decrease, which will increase both the flows generated and the value of the property.

When managing commercial real estate funds, we are committed to conducting independent property valuations every year, the aim of which is to reflect the fair market value of the managed property as effectively as possible, which, in turn, is reflected in the results of the funds.

The main assumptions of the valuation are the object’s future net income in time, the discount rate (to estimate the value of future cash flows now) and the capitalization rate – the ratio between the income generated by the building and its value in the market, which is determined by none other than the market itself.

The most difficult thing to predict is the capitalization rate

If all other circumstances remained the same, an instantaneous logical sequence of lowering the base interest rates would be possible, but in reality it “lags” and is not completely correlated. This is because the value of the object depends on many factors, the combination of which determines the change in value.

The most difficult component of asset value to predict is the capitalization rate, which is determined by the market – the transactions completed. Investors, when buying or selling objects, are influenced by monetary and fiscal policy expectations, financing conditions, liquidity needs, perception of risk premium and other factors. What seems like a good deal to one person, because you need to make an investment here and now, to another may be a complete mismatch of return expectations.

In addition to the market, the object’s value is strongly determined by the cash flow generated by that property, the conditions for ensuring that flow (available rental contracts) and the necessary investments.

Nevertheless, in the long term, the ECB, by reducing base interest rates, increases investors’ appetite for debt, and at the same time tolerance for a higher price – this leads to changes in capitalization rates. The start of the ECB’s interest rate reduction and the expectations of repeated reductions are positive news for the objects we manage. Real changes in market demand will be seen a little later. So you just need a little patience.

In order to maintain good object values, it is important to pay attention to object occupation, technical condition and efficient capital structure, which ensures returns for investors. But in summary, I believe that interest rates should lead to higher prices.