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The sensitivity of UK commercial property values to interest rate changes

Author

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  • Bryan D. MacGregor
  • Nanda Nanthakumaran
  • Allison M. Orr

Abstract

Duration and convexity measures are commonly applied in the management of bond portfolios to measure the sensitivity of asset values to changes in interest rates, enabling fund managers to manage their exposure to interest rate risk. Yet, there are no commonly accepted methods for applying the concepts of duration and convexity to equities and real estate, making it difficult for fund managers to analyse the exposure of multi-asset portfolios to interest rate risk (Blitzer & Dash, 2004). This paper contributes to this underdeveloped area of interest rate risk management by assessing the accuracy of using duration and convexity to measure the sensitivity of commercial property values in the UK to discount rate movements. Simulations confirm that property has duration and convexity characteristics similar to bonds. Our estimates overlap with duration figures estimated by Cairns and Wilkie (2010) for index-linked British government bonds over 15 years but are higher than their estimates for conventional bonds and five- to 15-year index-linked gilts. Perhaps more importantly, the paper demonstrates that duration is not sufficiently reliable enough to mitigate the interest rate risk attached to a property portfolio. The inclusion of convexity is necessary for effective interest rate immunisation strategies.

Suggested Citation

  • Bryan D. MacGregor & Nanda Nanthakumaran & Allison M. Orr, 2011. "The sensitivity of UK commercial property values to interest rate changes," Journal of Property Research, Taylor & Francis Journals, vol. 29(2), pages 123-151, November.
    • Handle: RePEc:taf:jpropr:v:29:y:2011:i:2:p:123-151
    DOI: 10.1080/09599916.2011.645861
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    References listed on IDEAS

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    1. Frederick R. Macaulay, 1938. "Some Theoretical Problems Suggested by the Movements of Interest Rates, Bond Yields and Stock Prices in the United States since 1856," NBER Books, National Bureau of Economic Research, Inc, number maca38-1.
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