Bond markets have been fluctuating over the last two weeks due to expectations and actual central bank announcements of increasing interest rates, tapering of quantitative easing and interpretation of inflation.
The Partners Fund portfolio has been prepared for any unlikely exogenous shocks by:
- Insuring our loan book is protected against rate rises, by writing floating rate loans.
- The 58% average loan to real estate value across the portfolio is more than adequate to protect against any potential asset value decline.
- Macro portfolio insurance to protect against a significant economic deterioration.
Whilst there has been a lot written and significant action in the bond market the magnitude of 10-year bond yield rises has been modest in the context of the last decade and gone virtually unnoticed when measured by the ever-rising direct equity and listed real asset prices.
We believe real asset markets have shrugged off the recent rising bond yield because there is optimism and increasing economic activity as the country “reopens”.
10-year bond rates in Australia and the USA are floating between 1.5%-2% yield.
The office and hotel sectors will benefit from the “reopening” trade and comparing commercial office yields to the 10-year provides some valuable insights.
- Typically, commercial office follows a similar trendline to the 10-year bond, at a 2.5%-3% yield premium.
- Office cap rates for core prime assets are currently ranging between 4.35%-4.85%. (Knight Frank), representing this long-term premium to the 10-year bond is currently fair value.
- According to JLL, prime office weighted average yields are 5.2% nationally, which is a record low but still well priced relative to the high bond yields.
- Overall, we believe most real estate markets had already been priced to allow for the increase in bond yields and are now closer to fair value.
- Higher material rate moves from this point will be required to put a dent in future property values.
Office assets make up 27% (on 30 September 2021) of the Partners Fund portfolio. The fund is comprised of well-diversified assets both under construction and existing across Melbourne, Sydney, and New Zealand. The underlying portfolio is meeting performance expectations of RBA Cash + 8%.
Data sources:
- 10-year Government Bonds (marketwatch.com)
- JLL Research, Bloomberg
