Has the anticipated increase in interest rates played its role in putting a cap on the investment activity in the Nordics?

Several market indicators are pointing towards the Danish property market cooling down, but the main question remains how hard the landing will be. It is now evident, that the market has most probably reached its full capacity in 2017 in terms of investment volume, with 2018-volume expected to contract some 10-20% y-o-y. The picture is rather consistent across the Nordic region, with Q1-Q3 2018 regional investment volume contracting by 20% y-o-y.

On a country level, Denmark has recorded the highest investment volume in the first three quarters of 2018, taking some 28% of the total Nordic volume.


Q1-Q3 2018


% of the Nordic volume

Q1-Q3 2017


% of the Nordic volume

y-o-y (%)































Source: CBRE Research

What is behind this descending trend? It was rather clear from the year start that sourcing core deals at this stage of the cycle will be one of the main challenges for investors in 2018. On the other hand, has the anticipated increase in interest rates also played its role in putting a cap on the investment activity?

Interest rates have fallen to very low levels in recent years, driving a substantial across-the-board increase in property prices in nominal and real (inflation-adjusted) terms. This fall in interest rates has been attributed to quantitative easing (QE) programmes in operation since the Global Financial Crisis (GFC). Over the past 12 months, the global economy has returned to robust growth, and central banks have signalled an end to QE and the start of quantitative tightening (QT). Some investors are therefore concerned, that interest rates will revert to pre-GFC levels, causing real estate prices to fall. This process has become known as interest rate normalisation.

No one is very clear about what interest rate ‘normalisation’ means. In part, it implies a world in which people can get a relatively good interest rate on their savings. It also means that central banks would cease to buy government bonds, allowing the market to set long-term interest rates. In all, normalisation implies that interest rates will return to pre-GFC levels.

It is, however, unlikely that the rise in interest rates will be nearly as sharp as some investors fear. Interest rates were falling long before the GFC, and demographic trends are expected to depress global interest rates for many years to come. A CBRE analysis suggests that real (inflation-adjusted) Danish long-term interest rates will be at just 0.1% in 10 years’ time. With inflation stable at 1.9%, this equates to a 2.0% yield on 10-year Danish treasury bills.

A direct effect on real estate is not expected even when the interest rates start to increase, as there is still a very substantial yield gap between commercial property and 10-year government bonds. The yield gap against prime offices in major EMEA cities is typically between two and four percentage points, supporting the capacity of these markets to absorb potential interest rate increases.

Usually, the spread between prime office property yields and local bond yields is used to determine whether the real estate premium stands on solid ground – or how much does it differ from the historical trend. The current yield gap in Copenhagen is 3.3%, while in Oslo it sits at 1.7% and could indicate a thicker cushion in Copenhagen to scale any potential interest rate increase.

The years of high returns from rapid yield compression may have passed, but a period of heavy yield decompression is unlikely. CBRE is not of the opinion, that yields will be completely stable. They will respond to rent-growth expectations and other factors. Recent and predicted increases in long-term interest rates might put some upward pressure on property yields over the next 10 years, but the potential impact is small – particularly if economic growth continues.

Why do real interest rates matter to real estate? The answer is a very close statistical relationship between real interest rates and yields. The long descending trend in yields dates from the mid-1990s and is not just a product of QE and the post-GFC world but is also heavily linked to the drop in real interest rates. Besides, yields are closer in economic terms to real interest rates than nominal ones.

There are other factors to consider. Institutional investors, who are loaded up on bonds, may struggle to meet retirement-income requirements in a period of sustained low real interest rates. As is now widely recognised, real estate is part of the solution. Therefore, CBRE expects a long-term structural compression of spreads to accommodate the mild increase in interest rates.

It is unlikely that the cycle in yield rates will ever vanish, but there are good reasons to believe that there have been structural changes to the level of real interest and yield rates that are not disappearing in the foreseeable future.