Bank of England cuts interest rate to 0.5%

bank-o-e-illu1On the back of the continuing sharp deterioration in economic activity, the Bank of England has reduced its interest rate by 0.5% points to 0.5%, the lowest since the bank was founded in 1694, reports PropertyEU.

‘In the UK, output dropped sharply in the fourth quarter of 2008. Business surveys continue to point to a similar rate of contraction in the early part of this year. Credit conditions faced by companies and households remain tight.’

These are tricky seas to sail when investing in UK property.

On the one hand, prices of commercial properties go down, yields go up, due to tight credit conditions, suffering businesses, lower expected rental values (ERV) and raising bankrupcy risks. In other words, direct property investments are repriced, in order to reflect the altered risk situation in the general economy and on the property markets specifically.

On the other hand, if you just look at the figures, you see low cost of capital (debt, at least), combined with high Net Initial Yields. Some call this a positive leverage effect. Not even two years ago, UK was facing a negative leverage effect, with initial yield between 4 and 5% and base interest rates at 5,5% or so.

Things to bear in mind:
– who is supplying debt and, at what margin?
– what is the implied risk premium on equity for property investors? (probably increases wacc)
– what is your base currency? (GBP was almost at parity with EUR recently, now 1,11 on the euro, used to be 1,5)
– to what extend will changing ERV’s affect the net initial yields? Especially when businesses go bust, lease prices will face real downward pressure.

On this last note, King Sturge expect that rental levels in London office markets drop by some 50%, but that regional centers will be less severely affected and will be less volatile.

Sure, there’s some logic to the repricing that is going on in the property market and to the opportunities this offers to investors. And, yes, I can see the angle. However, it surprises me allway how real estate agents try selling you their stories, in good times, bad times, mediocre times or even times where no-one really knows:

In the capital [London], King Sturge is forecasting rental reductions of up to 50% over the next two years, with the City and West End likely to be the first to emerge from the downswing next year. In addition, with office capital values having fallen by 35% since 2007, a shift in yields, lower interest rates and a weaker currency, the time is right for investors to consider assets, particularly in London.

‘For occupiers across the UK, this year offers the widest range of choice and the most attractive incentive packages for many years. Rents are lower than a year ago and in some cases it’s possible to obtain as much as two to three years rent-free.’

 So, investors and occupiers alike get bargains? Yeah right.