A rise in long-term interest rates is unlikely to impact significantly on property yields, according to a new study published by the Investment Property Forum.
The research, undertaken by Heriot-Watt University, forecasts how the gap between long-dated bonds and property yields might change over the next five years in the UK under different scenarios.
It concludes that the two yields are not likely to rise in parallel, provided rental growth is accelerating at the same time.
“With interest rates looking set to rise sometime in 2015, this is a timely and welcome piece of research from the IPF. I broadly agree with the finding that UK property yields will edge slightly higher over the next five years, and also do not expect bond yield rises to fully pass through to property yields, “ says Fergus Hicks, DTZ’s global head of forecasting.
The “central” scenario, assumes that 10-year gilt yields rise from 3% to 4% over the next five years and rental growth accelerates to 2-2.5% pa. In this case the interest rate rise is almost cancelled out, so that the equivalent yield on property rises only around 25bps.
But under a more pessimistic “stagflation” scenario, which combines inflation pushing gilt yields to 5% with disappointing economic and rental growth, property yields go up by 60bps.
And, unsurprisingly, with a “financial repression” scenario, in which the Bank of England re-starts quantitative easing and gilt yields remain more or less fixed at 3% for the next five years, equivalent yields barely change.
The research examined the gap between property and long-term bond yields over the last 30 years in the UK, USA and Australia and looked for potential structural breaks in the relationship.
Interestingly, it found that property yields are more closely related to those on index-linked bonds than with conventional 10-year gilt yields. “This raises the question of whether property investors have been looking at the wrong interest rate for all these years,” says the IPF.
The report, IPF Short Paper No. 19 The Implications for PropertyYields of Rising Bond Yields, can be downloaded via the Research Archive of the IPF website under the Short Papers Programme.