Last week, the 10-year gilt yield rose to 4.93% – a level not seen since the 2008 financial crisis. On the same day, the 30-year gilt yield soared to 5.37%, the highest level since 1998. There is a heady cocktail of reasons behind the hike, including bank rates, inflation forecasts, government policies and the Bank of England’s reversal of quantitative easing. The result will bring little cheer to the property industry, however.

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Gilts are a bond/loan the UK government borrows from investors to fund fiscal spending over various time periods, with 30-year loans at the highest end of the curve. Yields have risen because investors believe economic trends such as inflation will cut the future value of interest paid to bond holders as well as capital returned on maturity.

Rising yields push up government costs for new borrowing, while rising inflation adds to the cost of servicing existing debt. Both can cut the government’s ability to invest in infrastructure or other plans.

Rising bond yields and high inflation are not exclusive to the UK, but there are some unique circumstances here. The US, for example, is experiencing economic growth, whereas the UK has low growth as well as high inflation.

Jackie Bowie, managing partner and head of EMEA at Chatham Financial, says: “There has been a global phenomenon where yields have gone up, but the gap between the UK and other countries is widening, which is concerning. The [UK] fiscal position is unsustainable, and the market is sending a clear signal that something must change – possibly for the chancellor to either break her fiscal rules or increase taxes further.”

The direction of travel will not be a massive shock to the market, as gilt yields have been rising for a few months, but the sudden acceleration is still bad news for the property sector. For example, major housebuilders’ share prices fell on 9 January, the day after the record for 10-year gilt yields was announced, with Vistry down 3.35%, Persimmon down 1.65%, Berkeley Group down 1.61%, Bellway down 1.15%, Taylor Wimpey down 0.98% and Barratt Redrow down 0.15%.

Higher yields make investing in gilts more attractive, as it is a risk-free rate. Bowie says: “Compared with other asset classes, including real estate and infrastructure, gilts reflect the risk-free rate; so if the risk-free rate via a gilt is high, then investors might question allocations to other asset classes.”

Another challenge that bond pricing volatility poses for property is its negative impact on values. Daryl Perry, head of UK research and insight at Cushman & Wakefield (C&W), believes bond market repricing “will impact the price of debt and the value of real estate”.

Quilter Cheviot property analyst Oli Creasey says: “Rising borrowing costs will negatively impact the sector, as buyers require a higher yield on an asset for a debt-funded purchase to be viable. This should put downward pressure on asset values.”

But he adds that there has been little evidence of this yet: “Forecasts we’ve seen assume around zero change in property yields over the next three to four years, but we expect positive capital returns driven by inflation-level rental growth, which seems reasonable, given the flat shape of the two- to 10-[year] yield curve [the difference between yields from two- and 10-year gilts].”

Values recovering

Property values began to recover last year with an expectation that there would be more clarity on values in 2025 as interest rates fell, leading to an uptick in deals. Savills estimates that volumes for all UK commercial real estate investment hit around £47bn last year – up 15% from 2023 but down 30% from 2022.

Andrew Groves, partner and head of capital markets at Bidwells, says: “We believe the general commercial market bottomed out between Easter and summer 2024, and with uncertainty around the election having passed and interest rates on a downward trajectory, we are starting to see the green shoots of a pricing recovery. This improvement in sentiment and pricing looks likely to be slow and steady rather than rapid, as gilts remain stubbornly high post-Budget.”

James Carswell, real estate equity analyst at Peel Hunt, adds: “The second half of last year was characterised by stabilisation in values and the start of a recovery. This development [the gilt yield spike] is unhelpful for that.”

Carswell highlights that a number of REITs showed an uptick in asset values to the end of September. “Some portfolios, such as British Land’s retail parks and Landsec’s shopping centres, have even seen some hardening in equivalent yields,” he notes.

Last year’s recovery in values did not include all asset types, however. Those that fail to meet environmental, design technology or customer requirements of the future run the risk of becoming stranded. So, any uptick in deals will continue the bifurcation between prime and secondary real estate.

Housing hit: Persimmon was among the major housebuilders to suffer a share price fall when gilt yields spiked last week

Chris Taylor, head of real estate at Federated Hermes, says transactions are expected to rise as confidence builds across property markets, “but only for ‘relevant’ real estate – and that definition has sharpened as occupiers have adjusted, but for many other assets we can expect further capital declines”.

Zsolt Kohalmi, deputy chief executive and global head of real estate at Pictet Alternative Advisors, says: “There have been too few trades to really talk about ‘pricing’ per sector or geography. The European market has mainly been in hibernation, and pricing was therefore very choppy and depended on the motivation being higher for the buyer or the seller. We believe the upward inflection point will only come for assets where there is demand.”

Similarly, Ben Barbanel, head of debt finance at OakNorth Bank, says: “We are excited about 2025, because we want to lend circa £2.2bn. But there are still question marks around whether there is a decent enough supply of builds to deploy cash into. There must be a willing buyer and a willing seller.”

High interest rates were a key reason for the fall in transactions in 2024. Bowie says: “The expectation was that in 2025, refinancing would start to pick up. But this gilt yield spike has put a question mark on whether that is now a feasible path to take.”

Question mark over refinancing

Amid the challenging environment, there is a window of opportunity for experienced investors with capital to deploy. Charles Ferguson Davie, co-chief executive and chief investment officer at fund manager Moorfield, says lack of clarity will lead many investors to sit on the sidelines, reducing competition for good-quality assets in the right sectors that have favourable long-term fundamentals.

“There will be opportunities to acquire attractively priced assets where experienced investors with active asset and operational management capabilities can deliver enhanced value creation,” he says.

Mark Kildea, chief executive at the Howard de Walden Estate, adds: “For those with conviction and confidence in their strategies, 2025 could offer a host of investment, acquisition and signing potential, with pricing and valuation at an attractive level.”

Matt Thame, co-founder and chief executive of Cohort Capital, says: “Many hamstrung REITs and private equity investors are still stuck with assets that can’t be refinanced due to stringent [debt-service coverage ratio] requirements.

“As a direct result of investment yields pushing up, we have seen a new spell of LTV [loan-to-value] breaches. The road ahead will be challenging, but for motivated investors it is not without its opportunities – for instance, we can pay a percentage of the interest due under our facilities in kind, leaving sufficient headroom from a debt service point of view.”

Meanwhile, rental growth is expected to absorb most of the impact of UK bond market turbulence on property, Creasey says, adding that this is particularly strong “in sectors such as prime London offices, industrial and logistics, retail parks and build to rent [BTR]”.

According to Matt Saperia, real estate equity analyst at Peel Hunt: “Rental growth is a key ingredient of sustainable real estate returns, and there is ample evidence of this in the listed sector. Companies reporting recently have demonstrated healthy uplifts in rental values.”

John Dunkerley, founder and chief executive of Apache Capital Partners, adds: “With interest rates likely to be higher for longer as a result of stickier inflation, sectors with inflation-hedging qualities such as BTR, where you can reset rents on at least an annual basis, will prove extra attractive to institutional capital.”

The consensus among analysts is that real estate is still on the road to recovery and growth, but at a slower pace.

C&W’s Perry says: “The post-Budget response and first weeks of the year show the market will continue to be affected by bond pricing volatility. Nevertheless, the discourse is not solely centred around inflation but [also includes] growth – with significant geopolitical risk and potential volatility attached.”

He concludes that while elevated risk-free gilt rates “will act as a drag on liquidity, particularly for big investments”, C&W’s Timing the Investment Market Entry/Exit research “shows the majority of sectors are now in the inflection point of the market”.