IPF study questions impact of rising bonds on property

Research probes relationship between property returns and gilt yields

The Investment Property Forum is to publish a study into the effect on property of rising bond yields. As central banks taper quantitative easing, the implication is that gilt yields will rise. Conventional wisdom holds that property suffers when bond yields rise; as the cost of capital goes up, there is a knock-on effect, lowering the pricing, returns and investment appetite for real estate.

The study, which was carried out by Herriott Watt University, will be published as an IPF short paper soon. The research aims to answer two questions: what are the main factors driving UK property equivalent yields?; and what implications would a significant rise in long-dated gilt yields have for UK property equivalent yields and total returns?

A 2012 paper by Towers Watson comparing gilt yields and property returns over 24 years did not find any evidence that there was a relationship between the two. Meanwhile, a study by Blackrock looking at US Treasury yields and returns between 1978 and 2004 found that US real estate actually performed better during periods of rising interest rates than falling ones.

This was particularly the case “during times of economic expansion, when real estate has been able to produce strong fundamental returns driven by earnings growth”. These findings chime with the opinions of Anne Breen, head of property research at Standard Life Investments. She argues that the significant gap between average property yields and UK government bonds, currently around 300 basis points, plus support from rental growth, should mean that UK property returns can remain healthy.

“The cost of debt financing does have an effect, but at the moment there is still room for that to increase,” she said. “Bond yields are only one factor influencing returns – the others are economic growth, fund flows, construction and the health of listed real estate. We look at all these.” A rental recovery will boost returns, but Breen noted that the UK is at the very early stages of such a recovery and is expecting “quite a modest level of growth”.