We think that past movements in Czech bond yields mean that they are less appropriate to use in our valuation calculations. Using alternative bond benchmarks, re-calculated metrics support the view that industrial yields can fall further while office yields will mark time.
- We think that past movements in Czech bond yields mean that they are less appropriate to use in our valuation calculations. Using alternative bond benchmarks, re-calculated metrics support the view that industrial yields can fall further while office yields will mark time.
- Prague office and industrial property has looked overvalued on our valuation measure for some time and Q4 2020 was no different. (See blue bars in Chart 1.) When assessing a market’s valuation, we consider the difference between the current property yield and its required yield. This is calculated from the current yield of the alternative asset (bond yields and equity dividend yields) and the average yield gap between property and the alternative asset over the last 10 years. (See our Focus for more details.)
- That said, we think that using domestic Czech bond yields in our valuation score may miss the true picture. While national government bond yields are usually the most appropriate to use in comparisons this does not seem to be the case for the Czech Republic.
- This is partly due to specific Czech National Bank exchange rate policies put in place during 2013-2017 to stave off deflationary pressures. (See our Emerging Europe Update.) Significant foreign investor interest in Czech domestic bonds during the exchange rate commitment acted to keep bond yields artificially low for several years. (See Chart 2.) In turn, the yield spread between domestic bonds and Prague all-property was unusually elevated for much of this period. Given that our required yield measure uses the 10-year average of this spread, the distortionary effect of this period will be present in calculations for some time.
- As such, we looked at other measures to provide a broader view on current property pricing in Prague. Replacing domestic bond yields in our composite with other measures, such as the German Bund or the yield on the European BBB Corporate bond, suggests more favourable valuations. (See Chart 1 again.) This echoes with other evidence such as the RICS survey, where respondents’ views on current Czech market valuations were back at their long-run average in Q4.
- So, what does this mean for our forecasts? With Prague pricing looking less stretched, this supports our view that industrial yields will extend their falls this year and next, while office yields hold steady. In contrast, although retail valuations look favourable, the weak rental outlook means that retail yields will need to rise further to entice investors.
- Further ahead, even though the Czech central bank will likely be the first in the CEE to hike rates in 2022, rising bond yields across the region mean that the outlook for property yields is similar to other markets. We expect Prague property yields to edge up across all sectors from 2023 onwards.
Chart 1: Composite Valuation Score* (Q4 2020, %-pts)
Chart 2: Czech 10-Year Government Bond Yield (%)
Source: Capital Economics *All scores use domestic dividend yields
Yasemin Engin, Property Economist, firstname.lastname@example.org