EUROPE – Rising interest rates are not the major problem for property markets they are seen to be, and there is no correlation between real estate yields and Gilt yields, analysis has revealed.

Speaking at the annual conference of the European Public Real Estate Association (EPRA) in Paris, Exane BNP Paribas property analyst Nick Webb said: "Rising rates are not as big a worry for property markets as many people think."

Statistical analysis by the company revealed that the long-term statistical correlation between UK property equivalent yields and nominal Gilt yields was zero, he said.

Rather than the cost of borrowing, it was inflation expectations that appeared to be the key driver of property values, he said.

"So liquid and faster-reacting real estate equities actually tend to outperform the broader equity market in rising interest rate environments," he said.

Pension funds have historically allocated higher proportions of assets to real estate during periods when interest rates are high than in times when they were low, he said.

UK long-term interest rates had responded to the improvement in the UK economy, he observed, with the 10-year Gilt yield rising 100 basis points to 2.6% between May and July this year.

The recovery in the UK property market was the start of an upturn in the European listed real estate market, Webb said.

Trust that the British economic recovery would continue had spread from London to the broader UK commercial real estate market, he said, adding that this pattern was likely to happen in Continental Europe, underpinning shares of listed property companies.

"For the last few years, the strong performance of the London property market has made it feel like a different country," said Webb.
But now the UK property upturn finally seems to be spreading nationwide, he said.

"Capital values have already broken their 18-month losing streak, while key leading indicators – like the RICS survey – suggest 2014 could be the first year of average rental growth since 2007," he said.

He noted that, before the financial crisis, UK commercial property began falling sooner, faster and more severely than did real estate assets in Continental European markets.

"We may see markets on the other side of the Channel starting to take a similar shape in recovery, but again lagging the UK on the way up," he predicted.

As yet, the signs of life apparent in the UK are not visible in Continental European real estate occupier or investment markets, Webb said.

But there is good news, particularly for listed property companies that own prime assets in European cities.

"The retail property markets never suffered from the excessively high rents or strained affordability of the UK market, and retailers have proved far more resilient to weakening sales," he said.

Speaking separately at the EPRA conference, an economist warned that large increases in global interest rates were likely to hit property values.

Asked about the effect of rising interest rates on property yields, Ian Shepherdson, chief economist at Pantheon Macroeconomic Advisors, said: "In general, you can't see a doubling or trebling of interest rates and not see a response in other asset classes – it's just not possible."

However, although a rising rate environment is not good for capital values, if the momentum in values are already robust, they will not necessarily fall, he said.

"I'd like to think the US is strong enough to resist this, whereas, in the euro-zone, the question is much more open," he said.

If there is to be a 2-3 point rise in interest rates, growth in the markets might turn back down again, he warned.

"It's very much a story of how high the rise in rates was," Shepherdson said.