Lately, UK shares haven’t been stellar performers. With the British economy falling into a recession, the near-term outlook for equities is very uncertain. However, one positive trend that investors have enjoyed over the last few months is the steady decline in inflation.
Sitting at 3.4% versus 10.4% a year ago, the Bank of England is on track to cut interest rates as we approach the ideal inflation range of 2% to 3%. While this isn’t expected to occur until the third quarter, some economist forecasts are indicating the first rate cut could be as early as June, just three months away.
The exact timing remains a mystery. But that doesn’t mean investors can’t prepare. Lower interest rates bode well for a broad range of businesses. However, two from my portfolio that look set to surge on the back of rate cuts are Warehouse REIT (LSE:WHR) and LondonMetric Property (LSE:LMP).
Interest rates and real estate
The link between mortgages and property values is well documented. But as a quick reminder, higher rates make mortgages less affordable. This reduces the number of potential buyers, leading to a build up of unsold properties, creating a supply-demand imbalance. The end result is a widespread decline in property values. And that’s something that both Warehouse REIT and LondonMetric have had to contend with recently.
Both firms own and rent a diversified portfolio of commercial and industrial real estate. As the name suggests, Warehouse REIT’s asset portfolio primarily consists of warehouses, most of which are smaller last-mile style depots. LondonMetric operates with a similar model but focuses on much larger logistical facilities as well as some retail spaces as well.
The economic environment has created headwinds for both firms, with Warehouse REIT suffering a much larger blow due to its shorter-term leases and smaller-scale operation. The higher interest rates have also significantly impacted the book value of their real estate portfolios, resulting in a significant decline in share price since the start of 2022.
What’s next?
While the last couple of years have been tough for both enterprises, cash flows have remained largely intact. As such, dividends have kept flowing into the pockets of shareholders capitalising on their elevated yields. But with the Bank of England preparing to cut interest rates, the rebound of property prices could send these stocks flying. It may even be sufficient to undo any recent losses incurred.
What’s more, lower interest rates will also alleviate pressure on household budgets. With higher consumer spending, demand for well-positioned warehouse space could simultaneously rise, especially from ecommerce companies.
That could lend notable pricing power to these firms upon lease renewals with tenants. Not to mention the new expansion opportunities such a spark in demand could generate.
As promising as this outlook seems, it’s important to remember that there is still a margin of error. The magnitude of incoming rate cuts is still unknown. And minor drop may be insufficient to spark a rebound in stock price for these companies. Nevertheless, I remain cautiously optimistic, considering their impressive track records and long-term potential.
