The performance of global listed real estate markets will be sensitive to how central banks behave over the next few months, in particular to movements in interest rates triggered by changing central bank monetary policy, especially in the US, the eurozone and Japan (see recent real estate market performance in Exhibit 1 below).
Exhibit 1: Real estate market performance in the eurozone, Asia Pacific and the USSource: Bloomberg, BNP Paribas Asset Management, as of 14/08/2017
Many market participants remain optimistic about some degree of reflation in the US, which would most likely lead to a rise in longer-term interest rates in the US and elsewhere. We are slightly more cautious. Our expectations are that growth and inflation will continue along their current trajectory in the immediate future, with price pressures in the US, Europe and Japan remaining in check, while economic growth will likely be steady rather than spectacular.
There is the risk that any changes in ECB policy may lead to a spike in bond yields and spark a sell-off in eurozone property stocks. We anticipate, however, that any volatility surrounding a change in ECB policy will be short-lived; we believe the central bank has learned from both the ‘mini-tantrum’ triggered at the end of June by its public debate about the potential direction of future monetary policy, and from US policy precedents. While we acknowledge that the trajectory of bond yields is likely to be volatile, we believe central bank policy changes in the coming months will be gradual and could even have a surprisingly limited impact on real estate markets as current valuations have already taken central bank tightening into account.
Eurozone tapering: implications for European real estate
Recently, real estate investor attention has focused particularly on the possible tapering of quantitative easing (QE) by the ECB through additional reductions in its monthly Asset Purchase Programme (APP). The consensus view is that the ECB will try and normalise monetary policy as fast as the pace of economic recovery allows.
Here, to try and understand the potential consequences for European property of ECB tapering, we look both at the events in Europe since December 2016, when the ECB announced it was reducing the APP from EUR 80 billion to EUR 60 billion a month, and the experience of the US in the wake of the 2013 ‘taper tantrum’.
The APP is now proceeding at a monthly pace of EUR 60 billion and is set to continue until the end of December 2017. However, speculation has mounted that an announcement of the suspension of the programme will be made before the autumn of 2017 and that it will be wound down during the course of 2018. Market concerns increased after ECB President Draghi’s speech in Sintra, Portugal in June, with yields spiking over the summer and eurozone listed real estate stocks correcting somewhat.
To gauge how any additional scaling back of QE in the eurozone could impact real estate, we believe it worth looking at the experience of European real estate stocks since the ECB announced the reduction in the monthly APP to EUR 60 billion. European property returned 14.1% in euro terms over the intervening period, outperforming US real estate by nearly 10% and Asia Pacific real estate by more than 8%*.
There has been volatility in the performance of listed real-estate markets in recent months as they anticipated ECB policy moves. We saw this in June 2017 after Mr Draghi’s Sintra speech, when listed real estate in the eurozone fell by 5.1% between 26/06/2017 and 6/07/2017. That said, by 4/08/2017, the market had recovered 3.5% from the low point.
Tapering lessons from the US
It seems unlikely that the ECB will be hasty in raising short-term interest rates after the APP programme has been wound down if evidence from the US tapering process is anything to go by: the experience there suggests that while bond purchases may fall in volume, a quick reversal in short-term interest rates does not immediately follow.
The US Federal Reserve (Fed) began tapering its QE in December 2013 and through the end of October 2014, US real estate returned 22.4% from 18/12/2013 to 29/10/2014. The Fed raised interest rates 14 months after QE ended, at the end of 2015. The period between the end of tapering and the first interest-rate increase was volatile for US real estate and yet the MSCI REIT index, the RMZ, still returned 8% from 29/10/2014 to 16/12/2015 (see Exhibit 2 and 3 below).
Exhibit 2: Comparison of changes in the MSCI REIT index relative to the S&P 500 (on the basis of an indexation to 100 on 29/10/14 through 16/12/15)Source: Bloomberg, BNP Paribas Asset Management, as of 14/08/2017
Exhibit 3: US Treasury 10-year, Fed funds target rate and the MSCI US REIT indexSource: Bloomberg, BNP Paribas Asset Management, as of 14/08/2017
Although we would urge caution about drawing simplistic extrapolations from the US experience, what is clear is that an end to QE, if carefully managed by central banks, is not automatically accompanied by a sell-off in ‘yieldy’ stocks such as those of listed real-estate companies.
The unmistakable growing divergence in central bank policy looks set to continue and with it the potential to profoundly influence bond markets and thus listed real estate. Recent history in Europe and the US suggests that real-estate markets will face periods of uncertainty around these policy developments.
Despite additional tapering by the ECB and balance sheet reduction by the Fed, we expect central bank policy to remain generally supportive over the coming months. The balance sheets of the ECB and the Bank of Japan (BoJ) will still be growing for the foreseeable future, albeit probably more slowly. Capital market conditions should therefore remain largely supportive for listed real estate over the next 12 months in both the eurozone and Japan.
If there were a sustained return of inflationary conditions, bond yields would almost certainly increase more steeply, which would have a negative impact on real estate. Nonetheless, analysis of real-estate markets in the US and the eurozone during periods of central bank tapering shows that it is risky to assume that changes in QE by the ECB or the BoJ will automatically lead to significant underperformance by listed real-estate companies.
Written on 14/08/2017
*Eurozone real estate total returns in EUR, US real estate in USD, Asia Pacific real estate in USD. (Source: FTSE EPRA NAREIT, Bloomberg, 12 December 2016 to 31 July 2017)