Secondary property to suffer from bond yield rises: CBRE

Measures taken to restore public finances are most likely to affect secondary property rather than prime, according to a new report published by CB Richard Ellis.

The report examines whether increases in government bond yields in a number of European countries will negatively impact property market recovery .
Michael Haddock, director, Research and Consulting, CB Richard Ellis: 'Sovereign default or a country being forced out of the euro would impact the market for bond-like properties, but not to the extent that might be expected. The risk of a tenant defaulting on a rental payment is independent of the credit risk at a country level.'

If the recent strength in the real estate market has, to a significant extent, been driven by the yield differential between prime property and government bonds, then the recent increases in government bond yields in some European countries could arguably be expected to produce a negative impact on the property market recovery seen over the last year, the report says.

The historical relationship between the pricing of real estate and that of government bonds is a complex one because of the part-bond-part-equity nature of property and the fact that real estate is not a homogeneous asset class.

Each property has different characteristics and these (in particular, the length of lease and financial strength of the tenant) will make each asset more, or less, linked to bonds in its performance. This is particularly important in today’s market as a high proportion of the properties currently being traded, and for which there is greatest competition, are those with most bond-like characteristics - long leases to strong covenants.

CBRE says the simplistic conclusion is that if these properties have bond-like characteristics, and the yield on government bonds increases, then the yield on these properties ought also to increase, driving down the price. However, the real answer depends on why yields on government bonds are rising.

Interest rate rises are not driving recent bond yield increases, and they have not risen consistently across the Eurozone, but are confined to a selection of countries. The increased 'spread' between government bond yields in different Eurozone countries has been driven more by liquidity risk and the possibility of extreme events such as outright default or a country being forced out of the euro.