Real estate, alternative real assets and other diversions

The end of the UK interest rate cycle

The Fund Manager

Plus, reassessing the relationship between UK interest rates and REITs

The perceived wisdom has always been that reducing, and indeed low, UK interest rates are good for real estate in general. Equally, UK real estate investment trusts (REITs) (with their high dividend pay-out ratio compared to PropCos, and therefore their more bond like characteristics) are thought to be good for real estate. In particular, it has been assumed that there is an interest rate cycle. However, is this still case? Should some of these assumptions be revisited, to determine the true impact of UK interest rates on UK REITs?

In this article we will look at:

  • Has the UK interest rate cycle ended? 
  • Are UK REIT yields influenced by UK and/or US government bond yields, or have they disconnected?
  • How have the correlations between REITs and UK equities and bonds moved over time and where are we now?

Firstly then, the interest rate cycle. For this I have taken the period from the mid-70s until the present day to ascertain if a trend is discernible. Looking at chart 1, the evidence seems conclusive.

Chart 1 – UK base rates 1975–2019

Likewise, reading the latest pronouncements from the governor of the Bank of England and outgoing members of the monetary-policy committee (MPC), it would certainly appear that there is a general view amongst central bankers that a continuation of this low growth, low inflation, low interest rate, ‘Goldilocks’ scenario is a realistic possibility. Even the most cursory glance at the history of UK rates since 1975 would suggest that the historic spikes and boom/bust economics are a thing of the past. In fact, a similar glance at the longer-term history, going back to when the Bank of England was founded in the 17th century, would suggest that low interest rates are the norm, not the exception. Of far more importance than the nominal rate, however, is obviously the availability of credit in the system, and so margins; maximum loan-to-value ratios and loan capacity would appear to have a more important, and indeed cyclical, impact upon the REIT sector than pure interest rates going forward.

If interest rates are so low and potentially unlikely to spike upwards in a negative cycle, surely that must produce a tailwind for interest rate sensitive sectors such as REITs? Unfortunately, not necessarily, as the UK interest rate cycle is no longer the fundamental driver of UK REITs. As can be seen from the chart below, from the end of 2015 there have been two disconnections. Firstly, between UK REIT yields and UK 10-year bond yields. Is this incompatible? Not at all, as they both reflect worsening, underlying economic conditions and, of course, uncertainty post mid-2016 on the impact of Brexit. Also noticeable, however, is the way in which US 10-year bond yields have recovered, reflecting stronger underlying economic growth. This has also fed through to stronger US REIT performance compared to the UK. We can, therefore, determine that it is indeed US 10-year bond yield movements and inflection points which are a more significant driver of UK REIT prices than UK bond yields – for now, at least.

Chart 2 – UK REIT yields vs UK and US bond yields 2005–2019

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About Alex Moss

Alex Moss

Alex is responsible for developing the newly created Centre for Real Estate Research at Cass Business School. He also runs Consilia Capital, a research and advisory firm, which specialises in the performance and strategies of real estate, infrastructure and real asset funds, work that combines academic research with practical applications. He has been involved in research and transactions in the global real estate sector for over 30 years. His career has encompassed sell side research (BZW, Macquarie), investment banking (CSFB), private equity (Apax Partners Capital), and fund management (M&G and Investec). He is Chairman of the EPRA Research Committee, a member of the EPRA Advisory Board, and Chairman of the Investment Committee for the Investec Global Real Estate Securities Fund, where he acts as a consultant. Alex is best known for his academic and commercial work in the area of Global REITs, and their use in investment strategies. In 2013, with Professor Andrew Baum they produced two innovative papers for EPRA which received wide acclaim, looking at whether listed real estate was managed as part of the real estate allocation, and the wider use and applications of listed real estate securities in asset management. His work with Kieran Farrelly on combining direct and listed property for Defined Contribution Pension schemes won a Best Paper award at the 2014 ERES conference. A particular area of interest is the use of Smart Beta and automated trading strategies, most notably Trend Following and Momentum, and his work in this area with Professor Andrew Clare and Professor Steve Thomas has been widely cited. In 2017, with Reitsmarket he produced two multifactor Global REIT Smart Beta indices, which are listed on Euronext, and marketed by Goldman Sachs. Most recently he has been concentrating on the use of listed real estate within real asset strategies.

Articles by Alex Moss

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