Whether you’re a seasoned investor or just dipping your toes in the property pool, understanding how the Bank of England base rate plays a crucial role in property investment can make all the difference in your property journey.

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What is the Bank of England base rate?

It is an interest rate set by the Monetary Policy Committee (MPC) and is effectively the interest rate that banks pay to each other. The MPC’s aim in setting the base rate is to keep inflation low and stable - it’s for this reason that the base rate sky-rocketed over the last 2 years.  

Banks then pass this cost of their borrowing onto their own borrowers ie people taking out residential or commercial mortgages. This means that when the base rate is low, banks offer loans at attractive rates, and lower borrowing costs can translate to higher investment returns. Conversely, when the base rate goes up, banks tighten their lending criteria and raise interest rates, which make it more challenging to achieve desired returns.

Before you start expecting an immediate 25bps off your interest rate when the base rate is reduced by 25bps, banks do not pass on exactly the same rate to borrowers. Banks need to cover their costs (ie pay interest on people’s savings), so as base rates get closer to 0%, the less will be passed through to saving and borrowing rates.

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How do base rate changes affect inflation?

A change in the base rate affects how much people spend, and how much people spend influences how much things cost. Higher interest rates tend to encourage people to save more, whereas lower rates mean people are more likely to spend. By increasing the interest rate over the last 2 years, the BoE has been encouraging people to save more and spend less. In our humble opinion however, the slow ramp up of rates meant that it took a long time for people to actually start saving more and spending less, which is why inflation has taken so long to slow down.

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How do interest rates impact property investment returns?

The cost of capital is hugely impactful on investment returns, and borrowing costs are a cost of capital. If the cost of capital is lower than the property return (ie all-in interest costs are 5% and IRR is 10%) then debt is going to be accretive to returns, which means the levered IRR will be higher than the unlevered IRR. However, when borrowing costs are higher than the property return (ie all-in interest costs are 12% and IRR is 10%) then debt is going to reduce returns, which means that the levered IRR will be lower than the unlevered IRR. When returns are lower, then investors need to make changes to the business plan to increase the returns again, and the best way to do this? Buy the asset at a lower price. This is exactly what has been happening over the last few years – valuations and prices have come down. Unfortunately, however, there are a lot of sellers who don’t want to part with their asset for a lower price, and so they stop being sellers ie. no sales happen.

Over the last few years we’ve seen our clients bid on a lot of properties, but not manage to win them, because they just can’t reach a price that the seller is willing to accept. In anticipation of borrowing costs coming down however, we’re starting to see traction again and some of those bids are being accepted, and we are delighted!

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