Flattened interest yield curve seen to favor landlords conceptually

It's related to longer-dated interest rates.

Over the past month, the 10y UST yield has fallen 50bp from 2.59% to 2.09%, a level last seen in June 2013. Year-to-date, with the 10y UST yield having fallen 92bp but the three-month UST yield down only 5bp, the interest rate yield curve has flattened significantly.

According to a research note from Barclays, while lower interest rates should be positive for property prices, conceptually, a flatter yield curve should favour landlords and REITs more than developers.

The report noted that this is since office and retail cap rates are more closely related to longer-dated interest rates, whereas local mortgage rates are tied to Hibor and the prime rate, which are in turn related to the US Fed Funds rate.

Here's more from Barclays:

Despite the intuitive appeal, when we compare the NAV discount gap between the Hong Kong developers and landlords versus the interest rate differential between 10y- 2y UST yields, the relationship is unclear.

Instead, the NAV discount gap appears to be more closely associated with the movement of the 10y UST yield. In 2013, as 10y UST yields climbed from 1.75% to 3.01%, the developer-landlord NAV discount went from -2% to +6%.

However, this year, even as the 10y UST yield has fallen 92bp, the developers-landlord gap has remained at +8%.

While the direction of interest rates continues to be a source of debate, if one were to hold the view that 10y bond yields are likely to remain low or fall further, we believe the landlords and REITs should benefit.

On this scenario, we would favour Hui Xian REIT and Fortune REIT (both rated OW) and remain cautious on developers SHKP and Henderson Land (both rated UW).