Industrial Yields; Headed into Unchartered Territory

Normally, when we visualise numbers, they are evenly spaced out, as on a tape measure.

Yet this may not be how we innately think of them. Studies on young children before formal education, and some remote Amazon tribes, show we may more naturally conceive of numbers not linearly but logarithmically, where the space between numbers is not their difference (when subtracted) but their ratio (when divided).

For example, five is five times bigger than one, but ten is only twice as big as five. For this reason if asked to place the number five on a scale of one to ten, young children will not place it in the middle, but will naturally place it closer to ten.

Seeing the space between numbers linearly is useful for many modes of thinking and tasks.

But we still tend to naturally think logarithmically when thinking of the space between very large numbers.

Said one way, a ‘million’ seconds may instinctively feel like it’s closer to a ‘billion’ seconds than it is to ‘one’ second. Both a million and a billion are very large far away numbers. But we can change our spatial perspective; respectively a million seconds amounts to 12 days, and a billion seconds 30 years. Seen from this perspective we see the spaces linearly again, with a million much closer to one than it is to a billion.

Why does this spatial perception of numbers matter to Real Estate valuation?

Ten years ago a prime industrial & logistics warehouse would have had a yield of around 6.50%. And if demand rose we would talk about yields moving in with say a 25-basis point increment.

From 6.50% this increment would increase the value by 4%.

With prime yields now at 4.00% (and trending stronger) another 25-basis point movement in on the yield improves the value by 7%, or by almost twice as much.

We can see above that each 25bps yield improvement has an exponentially greater impact on value than the last.

And thinking of numbers only in linear terms becomes more misleading the closer we move towards zero. If an asset priced at a yield of 3.00% has a 25 basis point improvement we see a 20% increase in value, and an asset priced at 0.50% moved in by the same 25 basis point increment now sees its value increase by 100%.

Recently some of the most in-demand industrial and logistics properties have been trading at record low yields sub 4.00%.

As yields head ever lower, into unchartered territory, valuers will need to recognize that each 25bps yield improvement has an exponentially greater impact on value than the last.

One way to appreciate this is to try to visualise the spaces between numbers on a logarithmic scale.