23rd April 2025 | Evie Hillier | Commercial Property, Interest Rates, Landlords

Evie Hillier, Legal Administrative Assistant in our Commercial Property team, explores how higher interest rates have been reshaping the UK’s commercial property market. As borrowing costs have remained stubbornly high (in comparison to the record low rates seen during the period from August 2016 to 2022) and economic uncertainty persists, landlords, tenants, and investors are all facing unprecedented challenges.

As part of The Sherrards Training Academy, we have asked our Legal Assistants and Trainee Solicitors to write articles to support their learning, and also to ensure they start building their own personal brand. This article has been fact-checked and proofread by London-based Commercial Property Partner, Guy Morgan.

The UK’s commercial property sector has been undergoing huge transformation as ‘sticky’ higher interest rates have reshaped the market. Historically low interest rates for more than a decade up to 2022 led to a surge in property investments and development projects. However, interest rates increased sharply throughout 2022 and peaked at 5.25% for the period from August 2023 to August 2024. They now stand at 4.5%. Up until the seismic stock market turbulence of the last few weeks, there was speculation of further rate cuts during 2025, with rates predicted to possibly end 2025 at the 4% mark. However, with market uncertainty having been hugely exacerbated since 2nd April, the spectre of a potential world recession looms large. Against this volatile backdrop, it now looks increasingly likely there will be more (and potentially larger) interest cuts in 2025 than had been initially anticipated. Indeed, many economists are currently predicting 2025 ending with rates of between 3.5% to 3.75%. If these speculative rates turn into reality, this will be a welcome relief to landlords, tenants and investors who have all been facing higher financing costs and a shift in lease dynamics.

Impact on property values

Higher interest rates have had a direct impact on commercial property values. When financing becomes more expensive, the cost of acquiring and possessing property rises. This causes a downward pressure on valuations.

The volume of transactions has also slowed significantly since mid-2024. Investors who previously relied on cheap borrowing to secure deals are now more cautious, resulting in reduced demand for commercial properties. Office and retail properties, which were already under pressure due to changing post-Covid work patterns and consumer habits, have been hit particularly hard. Office space transactions have dropped by 20% year-over-year, while retail transactions have fallen even more sharply: by around 25%. The combination of higher capital costs and economic uncertainty has made investors more hesitant.

That said, relatively high interest rates have prompted a shift in investor preferences toward more stable, long-term assets. Industrial properties, for example, have become increasingly attractive. The rise of e-commerce and growing demand for efficient supply chains have made logistics and industrial properties a safe bet for capital deployment, despite higher financing costs.

Borrowing Costs: Challenges for Landlords and Developers

Landlords with loans maturing in 2025 are being cornered to refinance at much higher rates, which consequently leads to increased debt-servicing costs.

For developers, these higher financing costs have curbed new development activity. With only high-cost capital to fund projects, margins are thinner, and the financial risk is greater.

Shift in Lease Negotiations and Rent Expectations

With the transformation of the commercial property market, we are seeing an increase in tenants pushing back against landlords to secure more favourable lease terms.

  • Shorter Lease Terms –  Where we have been used to seeing 10 to 20 year lease terms, many tenants are now seeking 3 to 5 year terms, with flexibility as to break clauses. This reflects the broad economic volatility of the market and a desire for greater flexibility.
  • Fixed or capped rent increases – With inflation still elevated (the Consumer Prices Index currently lies at 2.6%), tenants are negotiating for fixed or capped rent reviews to avoid steep future costs. Some landlords have agreed to tie rent increases to more predictable measures, such as the Consumer Prices Index or a fixed percentage increase, rather than open market reviews.

At the same time, landlords, face their own cost pressures. To offset against these financing costs, many are seeking to increase, if not, maintain their rental yields. This naturally creates tension between landlords and their tenants.

Opportunities Amidst the Challenges

Those with access to cash or alternative methods of financing are positioned to take advantage of the opportunities that have arisen amidst these challenges.

Cash buyers are gaining a competitive edge in the current market. With higher borrowing costs negatively affecting debt-reliant buyers, those with capital reserves can acquire assets at more attractive valuations.

Although the British Pound has been volatile in recent years, this has heightened the attractiveness of UK commercial property for foreign investors: the weaker Sterling is, the greater the purchasing power of certain international buyers. Essentially, with a weak currency, UK assets are more ‘affordable’ in relative terms.

Alternative financing models, such as private equity, joint ventures and debt funds are also increasingly popular, to fill the growing funding gap. These flexible structures are helping developers and landlords operate within the higher-rate economic environment.

The UK’s commercial property market is undergoing tremendous change. It now looks inevitable interest rates will drop ‘further and faster’ in 2025 than had been previously forecast due to the inflammatory geopolitical situation. This will provide many with some respite, on one level, although those who are refinancing will face repayments that are still significantly higher than they were, pre-2022.

Investors are also likely to look to UK commercial real estate as a safer haven for investment than equities and bonds.

Those who can adapt their strategies, whether through alternative financing, renegotiating lease terms, or targeting resilient asset classes, will be well positioned to navigate this evolving landscape. Flexibility, foresight, a deep understanding of market fundamentals and pure luck will be essential in 2025. Whilst the commercial property market has been under pressure, there remain opportunities.

To find out more, please contact the Commercial Property team.