Yield curve inversions and triple net lease real estate

This article was written by our Vice President of Operations, Tim Lee. His experience spans real estate and financial services, and he is uniquely suited to evaluate the potential impact of yield curve inversions on real estate investments.

A lot has been written and discussed in the media about the recent “inversion of the yield curve.” For months the press has been on “Inversion Watch” with screen graphics, pop-up ads, and pundit interviews garnering every point of ratings they can squeeze out of it.

Recessions and yield curves … oh, my

Why is so much attention being paid (other than for ad revenue) to this esoteric interest rate measurement? Should we even care about it?

The difference between the 2-year and 10-year treasury yield, or the “spread” between the yields, has an impressive predictive track record. This makes for great headlines.

Over the past 40+ years, the 2-10 spread (as it’s called in the financial world) has predicted with 100% accuracy all 5 recessions – 1980, 1981, 1990, 2001 and 2008. On each occasion the 2-10 spread went negative an average of 22.9 months before the economy officially contracted into recession.

Now, recession is one of those words that has a very specific technical meaning, but is often used with less precision in the wider world. From a technical perspective, recession is defined as two consecutive quarters of negative GDP growth. In a colloquial sense, however, this word means something between “lean times” and “economic Armageddon”. 

The Great Recession, of course, still looms large – calling to mind images of senior bankers walking out of Lehman’s offices with boxes of their personal effects in the middle of the night. But recession doesn’t always equate to mass job losses and widespread economic destruction. 

Here is what past yield curve inversions and recessions have signaled

For us at 3 Properties and for our clients, counter-parties, and readers of this article there are more interesting questions: “what does this mean for net lease real estate?” Should we all hunker down in our basements and wait for the “all clear” to sound? Should we even pay attention to the talking heads who are tracking the yield curve so closely?

Let’s take a deeper look at the data to try and answer those questions.

As noted above, the 2-10 yield spread inverting has a 100% track record of predicting recession, with an average 22.9 months of prior notice. However, in the context of the real estate markets, this is not necessarily a harbinger of doom. Of the five recessions in the past 40 years, we’ve only seen negative annual total returns twice. Admittedly, the most recent negative returns were significant, surprising, and slow to recover.

Further to that point, as we’ve analyzed the impacts of past recessions it is clear that a recession does not automatically mean negative or even poor real estate investment returns.[1] In fact, during the same five recessions over the past 40 years, we’ve seen annual returns averaging more than 1.6%. While this is not a great outcome, it’s far better than many other asset classes. 

Additionally, three of the five recessionary periods weren’t marked by major real estate declines, and the average return for investment real estate was more than 9% annually.

In summary, our experience and research show the value of having high quality tenants contractually obligated to pay reasonable rent in generating desirable investment returns. With this data in-hand we continue to believe that careful underwriting of risk and careful management of landlord responsibilities are key to experiencing excellent investment returns.

1. NCREIF Property Index Returns. Retrieved August 26, 2019.

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