The Relationship between Bonds and Listed Property Trusts
The Australian economy is reflecting the events in the global stage as investors shift towards safer but lower-yielding bonds over high-risk, high-yielding property trusts. The sentiment of foreign investors is affected by the political and economic row happening between the U.S. and China.
The yield on the 10-year government bonds has risen a good amount by the end of 2017. It ended up around 2.75% which is a little higher from the 2.47% yield in November of the same year. Because of this, experts are anticipating a slump in the property market this 2018.
But why are investors shifting to bonds? What are the factors that affect this shift? What can retail investors do to make sure they ride the winning horse? Before we get to the answers to these questions, let’s tackle some basic questions first.
What is a listed property?
The Australian Real Estate Investment Trust (AREIT) is a property asset which is listed and can be traded in the ASX. It used to be known as listed property trust (LPT) but was later renamed to make the naming more consistent with the international convention.
An AREIT typically owns a number of properties that are too large to be owned by the average retail investor. Trading AREITs introduced liquidity to the sector and is viewed as a substitute for investing directly on a brick and mortar property. A REIT’s profit mainly comes from renting and leasing the properties they own.
AREITs are popular among investors looking for high-yielding assets because these companies are required to distribute at least 90% of their income to shareholders.
What is a bond?
A bond is a debt obligation or loan you give to an entity. The entity must repay you after a specified amount of time has elapsed. In this case, you lend money to the government at an agreed interest rate that will be applied upon maturity.
Bonds issued by the Australian government are generally safe and almost guaranteed to be repaid. Bonds are also less volatile compared to other investment vehicles which is why conservative investors often go for this option. This gives them a set cash flow they can expect to receive when it matures.
However, the price of bonds varies. It follows the change in the country’s interest rates. The price of traded bonds is inversely proportional to the imposed interest rates. This means when interest rates rise, bond prices fall down; when rates are down, bond prices go up.
Bonds don’t have to be held until they reach maturity. They can be traded in the open market and subject its price to the current market valuation.
How do they affect each other?
The value of listed properties and bonds depends on the interest rates the government imposes.
When interest rates are low, capital flows into properties because they’re cheap and provides high returns. Banks provide loans at lower rates, encouraging investors to get leverage and take advantage of investing in properties, whether they’re in the form of actual lots or LPTs.
As demand surges and supply decreases, prices go up and the government hikes interest rates to counterbalance the effect of this event. The increase in interest rates makes it more expensive to maintain property investments because of the higher mortgage and associated operating costs. The ratio of cost and profit in doing property business is reduced, forcing investors to look for other investments that will give them higher returns.
Bonds, on the other hand, prosper in times when rates are high. The returns may not be on par with AREITs but they’re relatively safer to trade.
The value of listed property investments is inversely proportional to that of bond yields. With the recent hike in interest rates, it’s better to position yourself in bonds and take advantage of what the market is telling you. However, make sure you stay liquid and have money to spare in case things take a turn for the worst.