Rental growth and investor interest set to shield property from bond yield hike

Property sector is robust enough to shrug off modest bond yield rises, AEW seminar speakers say

Increasing allocations to real estate and rental growth will help off-set “upward pressure” on UK property yields from rising bond yields, investors believe.

At an AEW Europe economic briefing in London on 10 April, the firm’s head of research Sam Martin reported clear signs that bond yields are rising, which will put “upward pressure” on property yields in the long run.

Conventional wisdom suggests that commercial property investment suffers when government bond yields rise, but AEW’s panel said there were important mitigating factors to support returns – at least for the next year or so.

Martin said increasing investment allocations to core property would help off-set any negative yield shift, especially given the undersupply of prime office stock, a limited development pipeline and the prospect of rental growth.

Evidence of rental growth starting to come through was central to Martin’s argument. He told the 130-strong gathering in London’s Centre Point that income yield has become a proportionately bigger – and more stable –  component of commercial property total returns.

Andrew Strang, former Hermes Real Estate chairman and now a consultant to Norges Bank Investment Management, said: “In general terms it’s a good thing for bond yields to  be rising modestly because it implies that the whole economy is now back on track, and that’s good news for property.”

He added: “I see bond yields as artificially low at the moment and think the market can cope if they go back up to 4.5% or 5%. I think that’s been in many investors’ minds over this past five-year period. “But if yields were to go to 6.5%, 7% or higher, I think that would do some quite serious damage to the property market.”

Rob Noel, chief executive of Land Securities, said the industry’s response to “structural undersupply” and tentative signs of rising occupier demand would be a greater determinant on investment performance than the current bond rate and interest rate environment, which he predicted would be “pretty benign” for the next two years.

Noel added: “The biggest influence on the market is the fact that requirements are changing from both office and retail space occupiers. If you have the right product, you will get quite good rental growth. But if you’ve got the wrong product, it will go backwards.”

If anything, Martin suggested, it is deflation that casts the longest shadow over property across Europe. “Deflation is a real risk and we’re likely to see lower rates for longer,” he said. “So that heat on rising government bond yields pushing up property yields is not likely to happen  for a few years.”