Study suggests Berlin industrial RE prices are 'frothy'

A recent report by consulting group Capital Economics on German industrial/logistics yields attracted our attention – in particular, how the spreads over office investments have come down to new lows. The study highlights how Berlin, among major logistics markets, caused their researchers the most head-scratching.

With the rise in online retailing and e-commerce, investment in industrial/logistics property across Europe (ex-UK) has increased by nearly 250% since 2010 – compared to a 167% rise in office investment and an 86% rise in the retail sector. Industrial investment has been even faster in Germany, growing by more than 350%. At the same time, German cities have seen some of the largest falls in prime yields, with Berlin in particular witnessing a 268 basis points decline – outpaced only by Dublin and Amsterdam.

While prime property yields have fallen everywhere, German industrial yields have fallen by far more than office and retail yields, albeit from a higher starting point. The spread in logistic yields over office and retail has now fallen to new lows, prompting the researchers to ask - have logistic yields fallen too far?

Given structural changes in the sector, the perceived risk premium in logistics is now lower while rental growth prospects are higher, so it's logical that prime yields should be lower today than in the past.

While logistic yield spreads in Hamburg and Munich have fallen back towards previous lows, the spread between prime Berlin industrial and office yields, at 145 bps, is 35 bps lower than it was at the time of the financial crisis. This suggests that investors have been much more aggressive in beating industrial yields down in Berlin, relative to other cities and assets. For example, while the spread in Frankfurt has also fallen below previous lows, this is in part explained by a more limited fall in office yields (compared to the other three cities).

The Capital Economics researchers applied their proprietary Valuation Monitor to gauge the relative value of property against alternative assets. This highlighted that current pricing in Frankfurt, Hamburg and Munich continues to be fairly valued – but pinpoints Berlin as being in overvalued territory. They qualify this by referring to Berlin's high historical yields, and concede it may not be a fair comparison given the definitively improved perception of the city over recent years.

They conclude that German industrial yields are NOT at unsustainably low levels, despite the fall in the spread over office yields in recent years. They expect yields to continue to fall, but suggest that spreads have reached a bottom - while warning that Berlin prices do look a little frothy.