Cheaper Debt Won’t Fix Valuations.
by Nick Barton Cliffe - Head of UK Investment
There's a debate running in our office at the moment that I suspect is running in a lot of real estate and investment businesses, so it's worth putting into the open.
The argument starts with the arithmetic of government borrowing, and on that basis it's hard to fault. US federal debt crossed $40 trillion last week, five months after crossing $39 trillion, and annual interest costs now exceed the entire defence budget. In the UK we spent roughly £111bn servicing central government debt last year - about 3.7% of GDP and close to a tenth of tax receipts.
The important number isn't the level, though; It's the gap between the average cost of the existing debt stock and the relative, marginal cost of new money. The UK stock currently costs around 3.9% on average. New ten-year money costs a little over 5%, and thirty-year money closer to 5.8%. That 130 to 190 basis point spread is the driver, and it only requires time to pass, because every maturing gilt refinances at the higher rate and drags the average up behind it. Run that forward on current policy and UK debt interest is expected to reach 4.7% of GDP by 2031.
Stabilising it in the orthodox way of raising taxes and cutting spending is not realistic. Borrowing at a blended marginal rate above 5% against nominal growth around 4%, on a stock at roughly 95% of GDP, implies you need a primary surplus of about 1.1% of GDP. We're running a primary deficit of around 0.7%. This reflects a permanent consolidation of roughly £50bn on top of all that already legislated, sustained across a decade, and no government of any political orientation has managed anything like it since 2010.
The more telling evidence sits in how the debt is being issued rather than in the totals. Of the DMO's £252bn gilt sales programme for 2026–27, only 9.1% is long conventional and 9.3% index-linked, against 38.6% short and 30.9% medium. The US has done the same thing through bills, which now represent over a fifth of marketable debt, with roughly a third of federal debt maturing inside twelve months against 24% in 2014. Sovereigns have stopped terming out because the long end is unaffordable, and in doing so they've converted themselves into something close to floating-rate borrowers. That mechanically hands the central bank control of the interest bill, which is why the fiscal dominance case has more force now than it did two years ago.
Where I'd push back is on the leap from there to "cuts are coming, so it is high time to buy everything."
The UK is arguably one of the more difficult places to express this view. Our gilt stock still has an average maturity of about fourteen years, so front-end cuts do far less for the Exchequer than they would for the US Treasury. A quarter of the stock is index-linked - the highest share in the G7 - which largely closes off the inflation route as well. The OBR's own ready reckoner puts 100bp lower short rates at £4.9bn a year and 100bp lower gilt rates at £9.6bn; a full 200bp parallel easing is worth about £29bn. Set against a £50bn structural gap, that's roughly half a fix in exchange for the Bank's credibility. Additionally, a central bank visibly cutting to accommodate the Treasury tends to widen term premium, not compress it - 2022 is the template, and the leveraged structures behind that episode haven't gone away.
For those of us underwriting real estate opportunities, the practical point is that we are exposed to two different curves and we routinely talk about them as if they were one.
Our debt costs price off the front and middle of the swap curve. At the end of July the two-year swap sat at 4.20% and the five-year at 4.25%, both above a 3.75% Bank Rate - the market already pricing a higher average path, which means some cuts are embedded in our margins before they happen. Our valuations, by contrast, price off the long end. Exit yields and long-run discount rates take their cue from a thirty-year gilt near 5.8%, the highest since 1998, while the MPC holds at 3.75% with three members voting to hike.
Those two things can move in opposite directions, and a curve “steepener” is precisely the scenario in which they do. Interest cover improves immediately as SONIA falls. LTV headroom doesn't, because values are anchored to a long rate that hasn't moved. Investors can be materially better off on debt service and no better off at all on capital value.
What’s worse, the scenario most likely to deliver the cuts - a labour market that finally cracks - is the same scenario that damages occupier demand and rental growth. Real estate yields are the risk-free rate plus a risk premium less expected growth. If the risk-free leg holds and the growth leg deteriorates, yields may widen even as money gets cheaper.
If investors are looking for an early signal, they should not watch Central Bank Rates. Instead, the focus should be on the balance sheet. Quantitative tightening is the cheapest lever available to reverse because it can be dressed as market functioning rather than a change of stance, and the Bank is still conducting outright gilt sales into a 27-year yield high. Slowing or halting those sales, or a mid-year cut to long and index-linked supply from the DMO, would indicate more than any speech. The next decision is the 17th September.
Cheap money helps you hold, but it doesn't automatically make anything worth more.