The previous post looked at yield compression in seven selected European cities, below paragraph explores further what this mean for the sector as an asset class.
Due to changes in the 10yr government bond (UK 10yr gilt) rate and further declining property yields, the risk premium for property has again narrowed to historically low levels in London.
Market growth Capital growth is continuing in key markets with London leading the pack. This is especially supported by further declining vacancy rates across all seven markets. Madrid is has been the biggest mover over the period from capital value decline to a 19% growth y-o-y Q3 2014, despite still relatively high vacancy. Capital growth (Q3 2013 – Q3 2014)
Property yields vs interest rates All seven markets have started to display signs of yield compression. As a result of a further downward adjustment of 10yr government bond rates property yields remain at a healthy premium in most markets. Smallest premiums are achieved in Southern Eruoepan property markets such as Milan and Madrid, where property yields have started to decline more rapidly between Q3 2013 – Q3 2014. Change in property yields (Q3 2014 – Q3 2014)
Property leverage market health Although there is still a healthy gap between London property net yields and the 10yr UK gilt rate (due to extremely low gilt rates), property financing is becoming more expensive if property yields keep declining further in the West End or the City of London in 2015. Yield gap (Q3 2014)
In contrast available cheap lending margins in Germany allow for higher property income returns in Germany. (Data sources: Bloomberg, CBRE)