Yield research paper from Savills
Yields are converging and some have already exceeded the previous downturn levels. Over the course of 2008 we have noticed a convergence in European yields. In the middle of 2007, at the peak of the investment cycle, the yield gap between the lowest and the highest achievable prime yield across all sectors and markets of our survey area was ranging between 300 and 500 basis points, as the yield compression in some markets was very strong (eg London, Paris, Dublin, Madrid) while now it does not exceed 300 bp.
This trend has continued over the course of the first quarter of 2009. Prime CBD office yields in the major European cities have moved out further and they now range between 6.0% and 6.5%, with the exception of Sweden at 5.5% and Frankfurt at 5.3%.
Thhe UK has been one of the first markets to experience a fast and significant yield decompression, being a highly leveraged and transparent market, followed by Paris, another sizeable and liquid European market. Spain and Ireland, also experienced early the downturn in investment activity and the consequent impact on yields. Investor demand for all these markets was strong, driven mainly by growing economies and easy access to debt.
Prime office yields had become as low as the long term interest rates, but following the financial crisis and the impact on the real economy the risk premium for property increased significantly, leading to rising yields. If we compare prime CBD office yields during the previous bottom of the European investment cycle in 2003 with their current Q1 2009 levels, London (West End), Paris, Madrid and Dublin have already exceeded their previous levels and are 50 basis points higher, except from Dublin which is 150 bp higher. We believe that this reflects the fact that this downturn is deeper and the economic fundamentals more unstable, compared to the 2003 market conditions, while the economic outlook is uncertain leading to low business confidence. This could lead to some further softening of yields in these locations until the end of the year.
However we believe that these markets are closer to the bottom of their investment cycle. We already see some renewed investor interest and we believe that most of yield decompression has been covered. On the other hand prime CBD office yields in markets such as Frankfurt, Amsterdam, Brussels and Stockholm are still lower compared to their 2003 levels, also reflecting significantly lower risk premiums over the long term interest rates compared to the previous downturn of the investment cycle.
Although market fundamentals may still vary slightly from one market to another, the strong convergence of economic and business cycles justifies the convergence and correlation of yields. We believe that unless the economic conditions or the banks’ appetite for lending changes, the markets that are lagging behind the investment cycle should see more significant price corrections this year.
