Bond Yields

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Commercial real estate is too cheap, according to one of the world's leading real estate academics, Professor Andrew Baum, the visiting professor of management practice at the Saïd Business School at the University of Oxford.
Professor Baum acknowledged the extremely attractive risk premium over bonds. 
"If you get 1.8 per cent on a bond, why is real estate trading at 5 percent? It would not surprise if the yields went down to 3.5 percent," he told the Australian Financial Review.
Professor Baum said most people assumed bond yields would rise but with a glut of savings around the world it could be some time till they turn.
"It is possible that yields will stay low for a long time, in which case property yields could go lower."
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Professor Baum outlined three possible scenarios.
1) Bond yields stay low, in which case, "property is a screaming buy".
2) Bond yields rise with Professor Baum estimating that the current yield gap could absorb a rise of 1 percent rise in bond yield without any more in real estate yields.
"Real bond yields you have to rise 2 percent before it affects real estate pricing," he said.
3) Inflation expectations and real bond yields surge beyond the 2 percent cushion.
"The question then is whether property is an inflation hedge," he said, pointing out that over 35 years in the UK, inflation had averaged 3.2 percent a year – and so had commercial rents.
Professor Baum says the second scenario is the most likely and Australia looks good with a relatively high property yield relative to local bonds.
Professor Baum is a chartered surveyor who will speak at the University of Sydney Business School CBD campus on the lessons from the European experience of real estate in a low interest rate environment on Thursday.
His visit comes as the latest Australia All Property Index has been released by the Property Council/IPD Australia. It provides a broad measure of investment returns for the commercial property market in Australia.
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The index database is comprised of property assets from 61 funds with a combined asset value of A$165 billion representing 1,419 assets.
The index details total return, income return and capital return for office, retail, industrial and other sectors on a quarterly basis.
The annualised total return for the year ending June 2016 was 13.3%.
This result is above the 11.8% return of June 2015 and above the 15 year annualised return of 10.5%.
Office returns were 14.6%, industrial 13.5% and retail 11.2% as at June 2016.
Cap rates for the quarter at an all property level tightened to 6.2%.
Retail cap rates tightened to 5.9%, office cap rates tightened to 6.2% and industrial cap rates tightened to 7.2%.
The composition (by value) across the sectors is retail (42%), office (44%), industrial (9%) and other (5%).
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Why Australian commercial property looks a good investment

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Strong interest has emerged overnight in Australia's first-ever 30-year bond.
Demand has pushed past the $13 billion mark, although the size of the offer is likely to be less.
The new bond, which matures 21 March 2047, was launched on Tuesday.
It is expected to be finalised today by the Australian Office of Financial Management. 
Traders told the Australian Financial Review the demand is likely to have come from insurance companies eyeing globally attractive long-term rates paid by a triple-A rated borrower, and short-term traders and funds looking to buy securities that will gain in value if a slowdown in China forces further Reserve Bank of Australia rate cuts.
As of late Tuesday, the AOFM had almost $11 billion of orders and was guiding towards a yield of 3.24 per cent. 
The Australian Office of Financial Management said the historic transaction would be of 'benchmark' size'. 
Traders had anticipated 100 to 107 basis points over the implied yield of the 10-year bond futures contract.  
ANZ, Citi, Commonwealth Bank, Deutsche Bank, UBS and Westpac managed the issue.
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Huge interest in Australia's inaugural 30-year government bond

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There is no Australian recession in the immediate horizon, if the yield curve is taken as an indicator, according to LF Economics latest analysis.
The research, Australian Economic Cycles and the Yield Curve, says the yield curve is an accurate predictor of recession and financial instability.
It relies on the 2-Y/10-Y bond yield curve, which it says can indicate larger downturns in economic activity, while avoiding the smaller declines and also the 90-Day/10-Y yield curve, which can detect both large and smaller declines in growth.   The economic forecaster says the economy will keep lumbering along without recession despite “anemic levels of real GDP growth, kept in positive territory only by our disgraceful population Quantitative Easing, public sector deficits, household sector dis-saving and record levels of private debt”.
It does note that shocks can swiftly make an impact.
The research is based on the premise that when yields on bond and bills with shorter-term maturities surpass longer-term maturities (the yield spread inverts), it is a “clear indicator economic growth will decline in the near future”.
Typically, the yield curve is calculated by subtracting the 2-Y Treasury bond yield from that of the 10-Y Treasury bond. The US provides a case study for demonstrating the accuracy of the inverted yield curve as a predictor of recession, usually one to two years in advance.
<a href="https://www.propertyobserver.com.au/images/2017/06/30/US10Yr.png" target="_blank">Click to enlarge</a>
<img src="https://www.urban.com.au/images/2017/06/30/US10Yr.png" alt="">
The Australian data is also accurate, it says. The quarterly 2-Y/10-Y public bond yield curve demonstrates the impending early 1980s recession, the near mid-1980s recession, the early 1990s recession and the GFC. It turns out there was plenty of warning for the GFC, with the yield curve turning negative in 2006Q2.
<a href="https://www.propertyobserver.com.au/images/2017/06/30/Aust10yearYield.png" target="_blank">Click to enlarge</a>
<img src="https://www.urban.com.au/images/2017/06/30/Aust10yearYield.png" alt="">
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<img src="https://www.urban.com.au/images/2017/06/30/AustTwoYields.png" alt=""> 
“Using the 90-Day bill/10-Y public bond yield allows for superior detection of future downturns in economic growth, including rises in the unemployment rate” says the research.
This yield curve picks up the small increases in the rate during the mid-1980s, 2001 and 2013/14, but these periods were not recessions. The mid-1970s recession is obvious, it says.
<a href="https://www.propertyobserver.com.au/images/2017/06/30/Aus90DayBill.png" target="_blank">Click to enlarge</a>
<img src="https://www.urban.com.au/images/2017/06/30/Aus90DayBill.png" alt="">
Recently, a research paper by the RBA attempted to detect historical recessions while filtering out noise by employing standard econometric techniques. It concluded that “Because the coincident indices present a smoother perspective of the business cycle in the 1960s and 1970s, they identify fewer recessions in this period than does GDP. Over the past 45 years, the coincident indices locate three recessions – periods when there was a widespread downturn in economic activity; in 1974-1975, 1982-1983 and 1990-1991.”
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