The potential repercussions of the “normalisation” of bond yields from their “artificially” low levels seems to be concerning a number of real estate researchers/strategists that I meet. Lots of presumptions are being made about bond market bubbles bursting and the potential effects on real estate yields. Is it worth looking back at the effect of the bond crash of 1994 – when bond returns fell by approximately 6%? A lot of commentators seem to use the 1994 bond crash as an apt comparison for the current situation. What actually happened to real estate returns when bonds “crashed” in 1994? Well, the effect seemed to have happened with a lag or be recorded with a lag (It can be tricky to tell whether real estate market prices actually react to capital market changes with a lag, or long transaction completion times cause price information on prices to emerge with a lag or appraisers take time to accept price changes or a bit of all or some of these effects). Following positive capital growth in 1993 and 1994, in 1995 the IPD All Property capital values index fell by 4%. This was pretty gentle compared with the relative carnage of 1990, 1991 and 1992 when IPD All Property capital values index fell by 13.8%, 10.1% and 9.5% respectively and consecutively without much input from the bond market. Real estate markets seem to be able to crash quite effectively with the help of pretty major negative supply and demand shocks in the occupational market.
There has been some work that has looked at the relationship between commercial real estate performance and interest rates more systematically. It suggests that the effects may not necessarily be negative – especially if rising bond yields are caused by an improving economy. Whilst increases in bond yields should, all else equal, lead to rising target rates of return, all else may not be equal. Rising bond yields may be associated with rising rents. Higher target rates of return due to higher bond yields may push cap rates up but higher expected rents should push down cap rates. The most difficult conditions are when bond yields increasing and the occupational market slows. I accept that there’s a lot of ‘mays’ and ‘shoulds’ here.