Differences in rental prospects and risk premia confirm our view that, despite looking overvalued compared to government bond yields, there is still scope for larger falls in industrial yields in the German markets compared to most southern European markets in the next year or so.
- Differences in rental prospects and risk premia confirm our view that, despite looking overvalued compared to government bond yields, there is still scope for larger falls in industrial yields in the German markets compared to most southern European markets in the next year or so.
- The recent release of 2020 investment data confirm the increasing attractiveness of industrial property. It accounted for 16% of total European investment, up from around 8% a decade ago. The strength of industrial investment activity and the stronger rental prospects compared to other sectors underpin our view that industrial yields can fall further this year. But is there more scope for this in some markets over others?
- As a starting point, an assessment of how the spread of industrial yields to government bond yields compares to history can provide an indication of where there is more room for yields to fall. (See Chart 1.) The fact that this spread is above average in most southern European markets suggests that there is scope for yields to fall. Part of this reflects that bond yields in these markets were elevated for much of the last decade. But, since we think bond yields will fall further this year, if anything this gap could grow wider.
- In contrast, the spread in German markets is particularly narrow compared to history, suggesting industrial assets look overvalued on this basis. And with German bund yields set to hold steady this year, there is little sign of this changing anytime soon.
- However, this fails to account for relative rental prospects, which will also influence required yields, particularly given the poor outlook for retail and uncertain future for offices. We think that industrial rental growth will average 2% p.a. over the next five years in Germany, compared to around 1% p.a. in much of southern Europe. (See our Outlook.) This indicates that there is much more scope for yield falls in German markets, and less in southern Europe, than implied by the spread to government bond yields alone.
- This is consistent with the fact that the spread between industrial yields in southern Europe and the euro-zone average has risen. (See Chart 2.) Indeed, the higher spread likely reflects that investors are relatively less positive about the rental prospects and risk environment in southern Europe. Admittedly, at these levels, the yield spread also indicates that pricing in southern Europe is starting to look more attractive on a relative basis. But history suggests that there is still some room for it to widen before this happens.
- Considering these factors, we believe that industrial yield falls will be greater in Germany than in most southern European markets in the next year or so. That said, the wide gap between yields in southern Europe and elsewhere suggests that a shift in relative pricing could be on the horizon.
Chart 1: Prime Industrial Yields Less National Government Bond Yields (Bps)
Chart 2: Southern Europe Less Euro-zone Industrial Yields (Bps)
Sources: Refinitiv, Capital Economics
Source: Capital Economics
Amy Wood, Property Economist, email@example.com