Rental growth in the UK is likely to 鈥渃ancel out鈥� a 100bps rise in 10-year government bond yields in the next four years, according to new research.
A study by Heriot-Watt University suggests that commercial real estate yields would only rise by around 0.25% between now and 2019 under a 鈥渃entral scenario鈥�.
Commissioned by the Investment Property Forum (IPF), the finding is based on what it deems the most likely outcome: 10-year gilt yields rising from 3% to 4% over the four years and rental growth accelerating to between 2% and 2.5% per year.
The research was intended to consider the implications of a rise in long-dated UK gilt yields for UK property equivalent yields and total returns.
By examining the behaviour of property yields and long-term bond yields over the past 30 years in the UK, US and Australia, the research has produced a number of findings, including an apparent closer relationship between property yields and index-linked bonds than with conventional 10-year gilt yields.
The finding has implications for assessing the risk premium of real estate.
鈥淭he yield gap between property and 10-year gilts is a useful benchmark, but it incorporates rental growth expectations,鈥� the report says.
鈥淎 purer estimate of the long-term risk premium for property is given by the yield gap between index-linked gilts and the property equivalent yield because both include inflation expectations.鈥�
The report, produced by Colin Jones, Neil Dunse and Kevin Cutsforth from the Institute for Housing, Urban and Real Estate Research at Heriot-Watt University, also considers alternatives to its central scenario and still finds little evidence to suggest a significant rise in property yields could be on the cards.
Under a stagflation scenario, with low economic and rental growth but accelerating inflation, 10-year gilt yields would rise to 5% but equivalent property yields might increase by 0.6%.
A 鈥渇inancial repression鈥� scenario, whereby the Bank of England resumes quantitative easing and gilts yields remain fairly stable at 3%, equivalent property yields would barely change.
