At the beginning of the COVID-19 pandemic, in their reporting on the first quarter of 2020, most real estate consultants provided their thoughts on yield projections. There was too much uncertainty, too little clarity and too little evidence, they said, as to how yields might change. One year on and the situation is somewhat clearer yet the long-range visibility remains clouded by uncertainty. In some sectors, such as retail and logistics, the developments that ultimately impact yields can already be identified vividly while in others, such as the office sector, there are too many factors that still cannot be foreseen with sufficient clarity, including future space requirements.

One thing remains clear, however. In comparison to secure government bonds (in this case, 10-year German Bunds) the yield spread compared with real estate remains sizeable. Nevertheless, the risk premium received for investing in real estate as opposed to secure German government bonds could be eroded going forward. Current projections assume that the yield on 10-year Bunds will rise moderately over the coming years, in part due to rising inflation (see also: What does rising inflation mean for the prime office yield?). Yields are expected to return to positive territory from 2023 for the first time since 2018, which will exert pressure on the narrowing of spreads. Rising bond yields generally have a negative impact on real estate markets. What this could mean specifically for prime yields in the office, retail and logistics sectors is explained below.

Offices: The yield spread peaked at 361 basis points in 2016. At that time, the prime yield across the top six markets stood at an average of 3.7% and Bund yields were in low positive territory. Since then, the prime yield has hardened by 100 basis points and bond yields have turned negative. At the end of 2020, the spread stood at 333 basis points. Looking ahead to the coming years, in view of the surplus demand in the prime segment, we can reasonably expect further modest yield compression. At the same time, current projections foresee a slight upward trend on Bund yields. This would produce a spread of still almost 300 basis points for 2021 and 262 basis points in 2022.

Retail: The prime yield on high-street properties in 1a locations softened modestly in the first quarter of 2021 for the first time since the previous crisis in 2008. The prime yield across the top six cities averaged 3%. The yield spread with 10-year Bunds currently stands at 341 basis points, which is the highest level since 1990. The structural risks in non-food brick-and-mortar retail are likely to result in yields softening further during the course of the year. However, since bond yields are projected to rise to a greater degree than those on retail property, the spread will narrow modestly over the coming years.

Logistics: The logistics sector has witnessed the strongest yield compression in recent years. Over the last five years, the prime yield has hardened by 160 basis points to 3.5% as at the end of 2020. This sector currently offers the largest yield spread of more than 400 basis points. With further yield compression expected on logistics property in both 2021 and 2022, the spread in this sector can be expected to show the greatest decrease.