Will yield spreads spread confidence?

During the decade following the Global Financial Crisis, investors became comfortable with a generous yield spread over risk-free rates. Between 2008 and 2021, the average spread of prime office yields and 10-year government bond yields was 284 basis points (bps) in Berlin, 271 bps in the City of London, and 221 bps in Paris CBD. 

This was driven by the ultra-low interest rate environment throughout that period; it meant that financing was almost always extremely accretive to returns. The sharp increase in interest rates over the past year-and-a-half wiped out this advantage and, in many instances, made debt dilutive to returns. 

While we don’t expect the yield spread to return to post-GFC levels, it is starting to rebuild as interest rates moderate and office asset yields continue to find new, higher levels. 

As of 12 December, UK 10-year gilt yields stood at 4.05%, down from a peak of 4.75% in mid-August, a reduction of 70 bps. 

German 10-year bond yields are 2.2% and French bond yields are 2.78%, both down 77 bps from 2.97% and 3.55% respectively, as recently as October. 

This is coupled with further yield movement. City offices drifted out 25 bps in December to 5.75%, where we expect them to stabilise, while Berlin office yields are expected to end 2023 at 4.2% and Paris CBD at 4.25%.

As a result, spreads now stand at 170 bps for London City offices, 200 bps for Berlin and 147 bps for Paris CBD. These are still below the post-GFC average but comfortably above the averages seen between 2000 and 2005, a time when interest rates were more fluid, and significantly above the levels of the end of Q3 2023. 

Average spreads, prime office yield over 10-year government bond yield

_{Source: JLL, Oxford Economics, Refinitiv}

Swaps have fallen substantially too, with the five-year SONIA rate currently at 3.85%, down 142 bps from a peak of 5.27% in July, and five-year Euro swaps at 2.71%, down 63 bps from a peak of 3.34% in late September.

This creates better financing conditions, with broadly stable margins resulting in falling all-in debt costs — and approaching the point where debt may once again become accretive.

These factors are beginning to make the investment environment feel more attractive than it has in recent months. Added to continued strong prime rental growth in many markets, return expectations are also improving. Confidence and transparency are returning to underwriting processes.

Where bidders and buyers can appropriately mitigate risk and are comfortable with the timing, and the more stable outlook, we expect this to translate into both better investor sentiment and transactional activity in the coming months.