Delegates at the 11th PERE Summit: Europe heard today how the spread between prime property and government bond yields would need to narrow significantly more than the historical average before institutional investors would worry.
Speaking on a panel entitled 'Deploying capital in a crowded marketplace', Laurent Lavergne, head of fund management for separate accounts at Paris-based AXA Real Estate, predicted that the spread between core real estate and government bond yields, in the current financial markets context, would likely need to reduce to just 150 basis points before institutional investors considered pausing their real estate investment strategies.
That estimate is at least 100 basis points from a historical average spread of between 250 basis points to 350 basis points. Currently, the spread in Europe, for instance, is still beyond the 250 basis point mark, even though prime property yields have compressed significantly in recent years. That is because government bonds have remained meaningfully low, often around the 0.1 percent mark.
Nonetheless, Lavergne pointed out that predicting the spread has become increasingly challenging as bonds have become more volatile and less liquid than they historically have been. In Germany, for instance, they reached 0.8 percent in recent months and Lavergne pointed out how the bid-ask spread for such assets has widened.
He further pointed out how a liquidity premium once associated with real estate was less expected than it was before the global financial crisis in the eyes of investors that investors had less of an expectation for a liquidity premium with real estate than the had before the global financial crisis. “The illiquidity of real estate is less important than it was before,” he said.
He also warned that it is challenging to compare core property yields across European cities, even if they offer the same yields: “that is for a very simple reason – the rents are not the same. And when it comes to properties in London, a large part of the price comes in the land. That is not the case, for instance, in German cities. I'd say rents are probably one-third of the what you are paying in London.”
David Ryland, partner at law firm Paul Hastings, who moderated the panel, said that investors should consider the role of government stimulus on both asset types when they consider comparisons between them bonds and real estate. He said: “The margin between real estate and bonds is still above the average. But do consider the 'artificiality' from quantitative easing for bonds and, arguably, for real estate too.”
The question of how tight a spread between core real estate and bonds investors will tolerate has come amid a morning when panellists talked widely about positioning effective strategies as core markets reach cyclical highs and as institutional investors continue to hunt property investments in the current low interest rate environment.