Offices less attractive in case of early QE withdrawal

DTZ has predicted that the withdrawal of quantitative easing (QE) could pose a threat to investors over the next five years, triggering a sharper and quicker spike in government bond yields, and reducing expected returns on office property.

A report published by DTZ explores the impact of QE withdrawal on the global property market, focusing in particular on the impact on 20 key office markets in Europe and the US up to the end of 2017. The report tests these markets under two different scenarios. Under the base case, the report details an orderly QE unwind, while in the early withdrawal scenario, support is withdrawn when economic growth surprises on the upside.

Under the base case, a rise in bond yields sees most key office markets in the US and Europe continue to look attractively priced for investors. The report states that although rises in bond yields driven by QE withdrawal will put upward pressure on property yields, this will be mitigated by a fall in risk premiums and overall improved lending market conditions.

DTZ predicts that the eventual unwinding of QE will imply a sustainable recovery in the economy. This would give rise to a stronger jobs market, stronger occupier demand – and crucially limited new developments – resulting in robust rental growth.

Also, the report explores a downside scenario of early QE withdrawal on the property sector. This second scenario has become more relevant as earlier this year bond yields around the world rose following comments by the Federal Reserve which predicted an earlier than anticipated withdrawal from QE measures.

The report states that early withdrawal could provide an unexpected short term surge in the economy in 2014. However, Central banks would then be likely to withdraw QE more quickly. This would lead to bond yields rising more sharply and see economic growth slow, with the US entering recession in 2016. As a result rental growth would suffer and office yields would be much higher compared to the base case. Under this scenario current property valuations look much less attractive for investors as expected returns are lower.

Fergus Hicks, DTZ’s Global Head of Forecasting, said: “With central banks considering how and when they will withdraw QE support we wanted to look at the impact on the commercial property market. Our base case is for an orderly withdrawal of QE, under which we see current pricing in most key US and European office markets as attractive. However, under our early withdrawal scenario all of the 20 office markets we looked at show a deterioration in pricing due to lower expected returns.”

On the basis of DTZ’s Fair Value analysis, 16 of the office markets covered in the report look attractively priced under the base case forecast, while under the early withdrawal scenario only 13 markets look attractive, with all markets showing a deterioration in pricing. In particular, the early withdrawal scenario sees four markets move from the ‘Hot’ to ‘Warm’ category, and three markets move from the ‘Warm’ to ‘Cold’ category[1].

Hans Vrensen, DTZ’s Global Head of Research, said: “Our base case assumes that the economy will show a gradual recovery, with the US and UK showing stronger growth than the Eurozone. This feeds through to stronger occupier demand and rental growth. Gradual rises in bond yields will put upward pressure on office yields, though we think this will be mitigated by lower property risk premiums. Our early withdrawal scenario shows a much sharper rise in bond yields and slower growth in the economy following a sharp rebound in 2014. This feeds through to lower expected return forecasts and makes office market pricing look less attractive than under the base case.”