Linkages between property asset returns and interest rates: evidence for the UK

This paper considers the effect of short- and long-term interest rates, and interest rate spreads upon real estate index returns in the UK. Using Joha nsen's vector autoregressive framework, it is found that the real estate in dex cointegrates with the term spread. but not with the short or long rates themselves. Granger causality tests indicate that movements in short term interest rates and the spread cause movements in the returns series. Howeve r, decomposition of the forecast error variances from VAR models indicate t hat changes in these variables can only explain a small proportion of the o verall variability of the returns, and that the effect has fully worked thr ough after two months. The results suggest that these financial variables c ould potentially be used as leading indicators for real estate markets, wit h corresponding implications for return predictability.