UBS Asset Management has warned that property pricing may have become too reliant on inflated bond prices and advised investors to heed markets that offer the most defensive returns against a backdrop of tightening monetary policy in Europe.
With the European Central Bank’s €2.4 trillion bond-buying program coming to a halt at the end of 2018, UBS predicts a gradual easing of bond yields but has said that if there is a faster outward movement of government bond yields than the “lower for longer” scenario, pricing in some real estate markets will start to look very stretched by 2020.
UBS has also cautioned against comparing the end of quantitative easing in Europe with the United States, where there has been a gradual tightening of monetary policy since 2016, which has not had a negative impact on property yields to date. UBS explains that because ultra-loose monetary policy has continued in Europe long after it was reversed in the U.S., the relative levels of yields between the two regions have become distorted. In addition, the volume of capital going into U.S. real estate has eased off in the last two years, while European transaction volumes have stayed at around or even above record levels, driving prime yields in core markets down to 3 percent.
In its September 2018 Research Blast paper, UBS also identified Milan as a market that is particularly vulnerable to bond yield movement.
“Italian bond yields are forecast to get to 4 percent by 2020 (from 3 percent currently),” writes the paper’s author Zachary Gauge. “This means property yields at the current level of 3.5 percent would have a negative premium. The spread would be eroded to near zero even under the lower for longer scenario. This is unless investors were to lose confidence in the government to such an extent that property is actually considered a safer asset to hold than an Italian government bond. Therefore, property pricing may stand in need of significant adjustments.”
