Market commentary: German logistics properties soaring: Long-term success or flash in the pan?

Thesis 1: Purchase prices and rental trends rise in equal measure

Yield and rent development with strongly varying pace

A disproportionate increase in purchase prices compared to moderate rental price development is considered one of the most striking indicators of hot markets. What is the situation in Germany? Looking back over the past 20 years, it can indeed be said that the development of multipliers has been much more dynamic than the development of rents. Since mid-2014 in particular, an increasing divergence of the two time series can be seen.

However, the higher the purchase price multipliers turn out to be and the more they decouple from the development of rents, the more long-term investors are dependent on a steady and rising cash flow from real estate management. What does the development of rents in Germany therefore look like?

Rent growth is only just beginning, but has been picking up strongly for some time now

For many years, the rental price structure for logistics space in Germany was largely stagnant. It took a full 27 quarters, starting in the first quarter of 2009, to achieve a single 20-cent jump in achievable rents. Since that time, however, clear movements can be seen and the iterations for the subsequent jumps are becoming shorter and shorter. In the last iterations up to now, this has usually taken only four quarters. A look into the future shows that it will continue like this for years to come. And even after the end of the forecast in 2025, the continuing shortfall in the supply of space will ensure increasing rents [Verlinkung zum Brownfield-Artikel]. At least this is the case if no external shock occurs.

Fig. 2 shows the rental price development in the eight top regions and especially for new contract rents for premium products. Investors who are not interested in quick sales profits but in regular distributions from ongoing real estate management focus on the long term. This can be seen well in the cash flow yield of the German Property Index (GPI).

Thesis 2: Despite everything, the overall interest rate remains positive

Strategies are based on developments in base rates or benchmark themselves against investment alternatives, e.g. ‘risk-free’ interest rates. In the eurozone, the current yield of German government bonds (Bunds) with a ten-year (residual) maturity is considered ‘risk-free’, because due to the very good credit rating of the German government, the default risk is considered almost non-existent. However, with minor cyclical fluctuations, current yields have been falling for many years and even turned negative at the beginning of 2019. So the investor loses money.

Fuelled by a lack of well-returning investment alternatives, the national and international investment market has been focusing on the German real estate market, and thus also the logistics real estate market, for several years. The consequence: net initial yields on real estate investments compressed more and more across asset classes.

Yield spreads still pronounced – Logistics still generates higher returns

In the meantime, there are more and more questions as to whether investments in logistics real estate are still attractive at all in view of the high purchase prices. Here it is worth taking a look at the yield spread, i.e. the net initial yield of an asset class in direct comparison to the interest rate of the federal bond. It can be seen that the ratio behaves very consistently despite the general compression. While the spread between the Bund and logistics real estate yields was around 430 basis points (bps) in 2008, it is currently still 394 bps. A comparison with the other asset classes shows a decrease, and logistics properties are approaching the yield level of office or retail properties. But one can still preserve a yield advantage of 60–80 bps difference. Despite all the inflation, the asset class is therefore still the most attractive option in a direct comparison. A purchase price reversal is currently taking place for retail properties, which is currently leading to rising yields.

Yield spreads of logistics real estate compared to alternative investments

Long-term performance (total return) still positive and above office and retail

Yield compression is significantly faster than rent development. The latter, however, is gaining more and more momentum. So what does this mean for the overall return on a real estate investment? It is also worth taking a look at the German Property Index, which is a long-term performance indicator for various asset classes based on market data. In addition to the specific transaction corner data, the GPI differs from the net initial yield in the time horizon, which is based on the time of purchase.
The GPI shows that logistics and industrial properties are significantly more stable in value over the long term than office or retail properties. Over the entire observation period from 1995 to 2024, the total return is never negative – in contrast to office properties, which fluctuate comparatively strongly with real estate cycles. Retail properties also oscillate more strongly, but never slip into negative territory in the retrograde view. In the run-up to the pandemic, office and logistics properties were able to record the highest annual rates of change in the history of the time series (17 to 20 per cent increase p.a.). With the onset of the pandemic, all asset classes suddenly lost momentum. This is most clearly seen in the retail sector, which is now slipping into negative territory for the first time after many years of already declining momentum. The forecast for the coming years shows net zero growth. Office properties will grow at a much slower rate of 2% to 2.5% p. a. Logistics and industry remains the asset class with the highest performance (+5% p.a.), even though the growth rates here are also significantly lower than in previous years. Accordingly, the forecast does not assume further rapid growth, but a return to moderate developments.

How do we see the future development?

Total return and the associated price development could therefore be more moderate in the future. Overheating would then no longer be an issue. When would such a scenario occur? For example, if the ECB raises the base interest rate again. At the latest then, tight calculations with little room for manoeuvre can become skewed. But when is this the case and how strong is the change? One thing is clear: the low interest rate policy cannot last indefinitely. However, we do not expect any significant changes in the short term. Among other reasons, this is so that economic growth in the eurozone countries is not stifled when the pandemic-hit economies are just beginning to recover. Rather, it will be more tentative changes over the next few years that will allow time for strategic adjustments. For a certain moment, yield compression will continue slightly. However, it will not reach the level of office properties. Things are getting exciting in retail real estate: due to the long lockdown during the pandemic and the e-commerce boom, confidence in retail real estate has been battered for a long time and a price correction has already started. However, high-street and specialist store locations, shopping centres and discounters will develop differently. Some can reach the level of premium logistics. For others, inflation will set in again.

Thesis 4: Logistics properties are underpinned in the long term by “real” user demand

Last but not least, speculative exaggerations are often mentioned. This essentially means unjustifiably high prices without coverage by solid demand along with stable cash flow from the operational letting business. This would be an overheating of the market due to a huge increase in property prices without the prospect of a later sale without losses, for example due to a lack of user demand and thus a lack of cash flow. Rent increases would also hardly be enforceable here. However, the increasing shortage of space indicates rather the opposite here as well.