Bond yields are setting new milestones as government borrowing costs across Europe continuing to collapse. Dovish central bank policy expectations are causing debt yields to fall even further, deeper into negative yielding territory. The German 10-year Bund yield – Eurozone’s benchmark - dipped below the European Central Bank’s deposit rate for the first time ever. In the case of the UK, 10-year gilts also hit an all-time low with the yield falling below the Bank of England’s policy rate for the first time in 11 years.
Bond yields and prices move in opposite directions, with the yields being determined by supply and demand dynamics. Sub-zero yields mean prices are high and investors are therefore accepting a loss to hold them. Looser monetary policy, with the US Federal Reserve expected to deliver a rate cut this month while the European Central Bank (ECB) has been vocal about the return to quantitative easing, has led investors to believe there will be an injection of liquidity in the market, further restricting the supply of bonds.
Although the relationship between commercial real estate and bond yields is relatively nuanced, with correlation analysis depicting a weak relationship between property and bond yields – movements in bond yields do shift and impact property yields. Nonetheless, other drivers such as rental growth and supply dynamics will have a greater impact. One thing that is clear is that the central banks have created an environment in which investors are yield hunting. As a result, real estate is continuing to draw in those who favour the steady income stream and relatively higher returns this asset class has to offer. Furthermore the low interest rates are prolonging this already mature real estate cycle. The latest Inrev investment intentions survey shows investors have an intention to place a minimum of €72.4 billion of new capital into global real estate.
Looking ahead, the demand for safe haven assets will likely to continue, in particular as global economic growth is fragile - placing further downward pressure on bond yields. Combined with the late stage of the property cycle investors will naturally gravitate towards core assets, however due to the supply constraints they may be obliged to move up the risk curve pursuing core plus and value-add strategies.