The decline in government bond yields has fueled a rally in real estate stocks.

The S&P 500's real estate sector climbed 17.6% from Oct. 25 to Dec. 6, compared to the nearly 8.7% rise recorded by the broader S&P 500.

The real estate sector, which fell 27.8% in 2022 and about 8.3% through the first nine months of 2023, has shot up as US Treasury bond yields have fallen, on anticipation that the Federal Reserve is done hiking interest rates and will potentially cut rates as soon as March 2024. Bond yields move opposite prices.

"Right now, I think the real estate sector has been rallying on the back of falling treasury yields," said Sonu Varghese, vice president and global macro strategist at Carson Group.

Yields drop

Since peaking at 4.98% on Oct. 19, the benchmark 10-year Treasury bond yield has fallen 86 basis points to 4.12% on Dec. 6. Yields move opposite to bond prices.

"Short-term and long-term bond yields have moved lower as markets are now pricing in five rate cuts in 2024, including the first one in March," Varghese said. "Even long-term yields have fallen, as longer-term rate expectations — the implied policy rate for 2027 — has fallen from above 4.50% in mid-October to around 3.7% now."

Stocks rise

Falling bond yields have bolstered real estate stocks both through expectations for lower financing costs and the nature of real estate investments, said Benedek Voros, director of index investment strategy at S&P Dow Jones Indices.

"Most real estate companies are structured as REITs and distribute the bulk of their earnings as dividends — tax free — which means that their biggest investor base is income-seeking investors, to whom real estate companies' dividends become increasingly attractive as bond yields go down," Voros said.

Expectations for rate cuts and lower borrowing costs have bolstered the real estate sector, even as concerns remain over the health of commercial real estate.

Varghese with Carson Group said these concerns remain, but prospects have improved as the odds of a recession in 2024 are diminishing, and lower bond yields will help assets on the balance sheets of many real estate companies.