Is it rational for listed property yields to be lower than bond yields?

05-09-2005

Since 1998, listed property yields have closely tracked those of long bonds, implying that investors view these assets in a similar light. More recently, however, listed yields have dropped below those of bonds. Since bonds are less risky than listed property, this begs one to ask, firstly, whether the listed property market is overvalued, and secondly, for how long can property yields remain below those of bonds.

Rode's Report editor Garth Johnson says that if one accepts that government bonds are less risky than listed property, then in a low and stable inflation-rate environment, with low and stable real interest rates, listed-property yields should only be higher than bond yields in those periods during which good income growth is expected.

“This is the phase in which the listed property market presently finds itself. Investors are currently willing to sacrifice some income returns, because they believe they will make it up through earnings growth.”

Regarding the sustainability of listed-property yields remaining below those of bonds, Johnson notes that as funds grow in size, the risk premium between bonds and listed funds may narrow.

“ When one considers funds with a market capitalization rate exceeding, say, R2 billion, how much risk is there really to speak of? In such cases, there is surely no reason why listed property-yields should exceed bond yields by much.”

So the conclusion is that in the short-term solid growth prospects should keep listed yields below those of bonds, whilst in the medium term the increased size of funds will be one force tending to keep listed yields at least close to bond yields, if not below them.