PROPERTY YIELDS OF COMMERCIAL REAL ESTATE: THE INFLUENCE OF INTEREST RATE

Abstract

This study examines the contemporaneous, dynamic and long-term influence of interest rate on the property yields of commercial real estate in Singapore. An exploratory analysis is first performed to trace interest rate and commercial property yield movements between 1990 and 2004. Exogenous shocks are deemed to have caused the deviation of commercial property yield from the theoretical flat trend. Commercial property yields rise (fall) sharply with risk premia during times when property investors are exposed to higher (lower) risks. In addition, excess returns to property investors after debt repayments have been rising in recent years. Generally, commercial property yield and interest rate are positively related. Empirical results suggest that for every 1% change to change in current interest rate, the change in current office property yield moves by 29.3 basis points in the same direction between 1990 and 2004. However, the interest rate coefficient in the regression model for central shop space is statistically insignificant. The Granger causality test also identifies interest rate as a good leading indicator of commercial property yields. Correlation analysis suggests an interest rate hike now will lead to significantly higher commercial property yields three to four quarters later. Thus, interest rate is adept in predicting the likely short-term movements of local commercial property yields. Finally, co-integration tests conclude the absence of long-term relationships between interest rate and commercial property yield in Singapore. Hence, the error correction model is not applied. In conclusion, the findings of this study are of significance and usefulness to property analysts and investors.