Expected property returns
when government bond yields are rising Conventional wisdom says that
property suffers when gilt yields rise.
In this paper, we show that no obvious
historical pattern exists between
property returns and yield increases.
Historical returns for property and
long gilts
Current gilt yields, like other government bond yields,
are near historical lows. This has prompted investors
to ask: Should we expect property returns to fall if
gilt yields rise?
In theory, rising bond yields could lead to many
different outcomes for property. As gilt yields
drive the cost of capital to borrowers, a yield rise
could reduce property returns. If higher inflation
expectations cause higher bond yields, though,
then properties with secure inflation-linked lease
arrangements could benefit. Given these two
plausible but different drivers of higher gilt yields,
and their differing impact on property returns,
we need to look further than theory. We therefore
consider the historical returns for property and
gilts, and summarise some previous research on
this matter.
We use the IPD Monthly Index as a proxy of returns
for UK commercial property. Returns on this index
are available from 1987, and so our analysis
begins then. We then measure the return on long
conventional gilts using the FTSE Over 15 Year Gilts
Index. Given the long investment horizon of pension
funds and the relatively limited history of the returns
data, we chose to consider annual periods. This
provided us with returns for 24 separate calendar
years, which we report in sterling terms.
In Figure 01 below, we compare the gilt and property
returns generated in these 24 years. We add one
extra detail, though, given that property returns are
appraised on a lagged basis, whilst gilt valuation is
immediate. That is, we compare property returns
with gilt returns from the previous year.
Given the slope of the best-fit line above, we
observe a correlation of +0.3 between these two
assets – an observation mirrored in our long-term
return assumptions. However, that correlation
reflects the returns in all years, not just those
occasions when gilt yields rose. 1 We therefore
highlighted these eleven occasions in red.
Figure 01. Comparing returns on property (vertical axis) with
those from long gilts in the previous year (horizontal axis)
40%
20%
2004
2010
2002
1997
1989
2000
1995
0%
1991
2007
-20%
-40%
-20%
1990
2008
0%
20%
40%
Can we discern a meaningful pattern from the
red markers above? Not really. There seems to
be no strong historical pattern between UK
property and lagged gilt returns in times of rising
gilt yields. For completeness, we also conducted
a similar analysis for UK property returns and
lagged changes in gilt yields, which we show in
Figure 02. The resulting picture looked very
similar, with yield rises showing no strong pattern
with ensuing property returns. 2
Empirical data therefore provides no support for
the view that property returns typically suffer when
gilt yields rise. To better analyse this view, we also
reviewed research from other organisations.
Research on rising yields and
property returns
Whilst research in this area is not widespread,
we know of a relevant study from BlackRock.3 Its
authors reviewed data from 1978 to 2004 in order
to analyse the impact of rising 10-year Treasury
yields on US property returns. As the authors said
about the study:
“The main finding is that real estate has performed
better in periods of rising interest rates than in
falling ones, particularly during times of economic
expansion, where real estate has been able to
produce strong fundamental returns driven by
earnings growth. The result is somewhat comforting
as market participants have grown increasingly
anxious regarding the potential negative effects of
rising interest rates on real estate returns.”
Conclusion
Many factors could drive property returns and not
just changes in gilt yields. However, conventional
wisdom seems to suggest that rises in gilt yields
lower property returns. As is the case with another
similar study, we find no evidence of this statement
in the limited returns data from the UK, although
we acknowledge that this view is sensitive to the
returns in particular years of our study.4
Figure 02. Comparing returns on property (vertical axis) with the
yield change of long gilts in the previous year (horizontal axis)
40%
20%
2004
1989
1997
2002
2010
2000
1995
0%
1991
2007
1990
-20%
-40%
2008
-3%
-2%
-1%
0%
1%
2%
3%
Further reading
BlackRock. Real estate performance in a rising
interest rate environment: an empirical analysis,
2005.
Penfold, Robin, Jane Welsh. Do REITs behave
like property or equity?, Towers Watson, 2009.
2 Factsheet title
towerswatson.com
Further information
For further information, please contact your Towers Watson consultant, or:
Dania Zinurova
+44 20 7227 2232
[email protected]
Robin Penfold
+44 1737 274462
[email protected]
Endnotes
1 Granted, the 24 years that we study generally exhibit economic growth and strong
property returns.
2 The overall pattern in this instance was downward sloping as yields move inversely
to prices
3 We know of several studies of interest rates and REIT returns. Given the nature of
REITs, however, these studies provide less reliable information on the relationship
between interest rates and property returns. For further information on this REITs,
see Penfold and Welsh (2009).
4 Omitting the return from 2008, for example, results in a discernable but modest
pattern between yield rises and negative property returns.
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