Higher Interest Rates Becoming New Reality

Uncertainty Remains the New Normal

In the past, a lack of certainty used to be a temporary emergency state, but recent years have resembled a revolving door of crises. There is now plenty of evidence that uncertainty has become a constant factor in any kind of business decision. Geopolitical conflicts, the steady increase in sovereign debt, structural issues plaguing many national economies and a fragmented global economy make it harder and harder to venture long-term predictions.

However, it is remarkable that the market response to this development has so far been comparatively rational. Neither equity markets nor capital market rates overreacted when the war in Iran started. For the time being, market players seem to assume that the global economy is sufficiently resilient to cope even with extended geopolitical jitters.

The true transformation has therefore less to do with short-term crises than with long-term trends. Inflation risks remain elevated, the sovereign debt of many countries keeps going up, and public-sector demand for capital will continue to increase long-term, even in Germany. The situation has created an environment that makes permanent interest cuts less and less likely. The most pressing question is no longer whether rates will fall or rise a little in the near term but, rather, at what level the long-term capital market rates are likely to stabilise in the years ahead. As far as key lending rates go, ECB Director Isabel Schnabel has lately advocated a rate increase this June.

Interest Rate Development

Interest rate markets presented a generally stable picture in May 2026, if on a slightly higher level. The 3-month Euribor moved predominantly between 2.18 percent and 2.28 percent, hovering at around 2.20 percent by month end. The 6-month Euribor fluctuated between 2.47 percent and 2.62 percent, and occasionally exceeded the highest levels seen this year to date.

On the long side, the stabilisation trend continued after the surge of previous months. The 10-year swap rate ranged mainly from 3.03 percent to 3.21 percent, and approximated 3.10 percent by the end of the month.

The development is remarkable insofar as many market operators had anticipated a far stronger reaction to the outbreak of war in Iran. What they got instead was stabilisation on a higher level. It seems that capital markets have largely priced in the geopolitical risks by now. This is not to say that the risks have gone away. But it does suggest that markets currently expect interest rates to stay permanently high rather than bracing themselves for another inflation shock.

Ramifications for Developers and Property Asset Holders

For property developers, the playing field has fundamentally shifted. Rather than pondering the chances for interest rate cuts, market observers should focus on ways to make development projects work even in a permanently elevated interest environment. Buyer financing is becoming more costly; at the same time, real estate investments compete increasingly with fixed-income.

This will inevitably have consequences for land prices. Development plots will either have to become more affordable or construction volumes will keep declining. The old adage that the profit lies in purchasing is regaining its significance.

In fact, we may even see a renaissance of business models that used to be standard in days past. The purchase prices for development land were often not paid before the respective development rights or the planning permissions had been obtained. Option models divided the risks among seller and developer. During the low-interest cycle, such constructs became largely obsolete. But we might see them become more relevant again going forward.Möglicherweise erleben wir sogar die Rückkehr von Modellen, die früher selbstverständlich waren. In vielen Projektentwicklungen wurde das Grundstück erst bezahlt, wenn Baurecht oder Baugenehmigung vorlagen. Optionsmodelle verteilten die Risiken zwischen Verkäufer und Entwickler. Während der Niedrigzinsphase verschwanden solche Konstruktionen weitgehend vom Markt. Es spricht einiges dafür, dass sie künftig wieder häufiger anzutreffen sein werden.

A question that presents itself to property asset holders is what interest rate strategy to choose. Those who keep hoping for interest cuts face a growing risk. Depending on their risk propensity and cash flow position, it may be a good idea to lock in their interest rates for another ten years.

Outlook

The real estate industry will have to prepare for an environment where, once again, capital has its price. While this does not necessarily make deals less lucrative, it does call for different business models. Adjustments will primarily concentrate on land prices, funding structures and investment decisions.

At the same time, we should acknowledge that fresh opportunities are emerging as well. Serial and modular construction are still in the early stages of their development. An environment of rising costs and increasingly scarce funding is exactly what could unlock the enormous potential associable with industrialised construction techniques.

The true challenge is not that interest rates are exceptionally high today. They actually remain in the mid-range, historically speaking. Rather, there is plenty of evidence suggesting that long-term rates are more likely to rise than to fall in future. Increased defence spending, growing investment requirements and limited willingness to implement reforms will drive up public debt, and this will certainly not increase the chances of a return to the capital market rates of recent years.

The key question is therefore no longer whether the real estate industry will have to adapt to higher financing costs. That process is already under way. Instead, the crucial question is how quickly land prices and property values will adapt to the new interest environment.