Of all the sub-sectors in the world of real estate, logistics has seen the greatest shift in popularity in the past five years, driven by strong fundamentals and the structural effects of Covid-shutdowns on consumer spending habits. Bohill Partners recently convened a group of senior individuals with a special interest in logistics to discuss the tumultuous year behind us and the future growth of this exciting sector.
All our guests agreed on one point: The impact of consumer behaviour on the way we shop in the UK and Europe has undoubtedly been the greatest catalyst for investor interest and occupier demand. But what does the future hold and how can investors navigate as we exit lock downs?
The extent to which Covid-19 has changed the sector, is it sustainable?
Demand has undoubtedly increased, both by occupiers (largely ecommerce led) and investors alike, however consensus is that the percentage of retail conducted online is likely to drop slightly when the vaccine is rolled out. The issue for investors is the availability of assets, owed in part to increased competition, but also to the lack of development pipeline. The demand for urban logistics is driven by the ever-increasing pressure for quicker deliveries and delayed built to suit projects, largely for big box out of town projects.
Another positive impact on the logistics sector in 2020 has been a general upward pressure on rents in both the UK and Europe, predominantly due to lack of supply. The general perception is that occupiers of last mile logistics assets are not concerned by a building’s aesthetic and are largely insensitive to rental pricing. The focus is on factors such as location, accessibility, traffic flows and space for parking and loading. These elements push rental growth more than anything. Our participants agreed that favourable demographic trends and ever reducing access to new land in urban centres, mean rental growth will be sustainable, at least in the short to medium term.
Occupier and investor requirements, how is this changing and what are the effects on valuation?
The type of investor interested in the sector and the level of sophistication in valuing assets have dramatically changed over the last 12-18 months. Our participants largely agreed that although some investors are learning by doing as they bid on assets and larger portfolios, many are becoming far more sophisticated about the intricacies of this nuanced sub-sector. One participant commented that their clients are focused on the longevity and stickiness of the occupier to ensure long-term, stable income. For example, a box that provides services to life-science and healthcare, which will often need special licencing to operate, will provide that stability for their end investors.
The baseline understanding for warehouses by investors across the industry has gone up significantly over the past two years, pushing investors and developers to evolve their offering to entice the larger, more sophisticated tenants from growing sectors such as pharmaceuticals. Landlords are therefore developing the right solutions in their properties for tenants, following the flexible and more dynamic approach of more traditional commercial real estate, such as offices and retail.
How do you offer differentiation of strategy to attract/deploy capital?
A pressure point for larger institutional fund managers keen to allocate large amounts of capital towards logistics and light industrial assets is how to achieve scale at pace with limited ability to deploy capital into often smaller sized urban assets. What was clear from the participants is that building a dedicated team is essential in giving the edge to source deals ahead of the competition. With shorter timescales, increased competition, and sophistication of investors, working hand in glove with capital partners is key to execute swiftly. The alternative is to buy a ready-made portfolio, but these are increasingly hard to find and aggressively priced.
Given the great strides the logistics sector has taken over the past 18 months, it is difficult to predict where it might be 18 months from now. However, it was broadly agreed by our group of experts that mixed-use developments are the likely route for urban sheds. With densification accelerating, multistorey warehousing and better use of existing assets is the likely path we are on in Europe. Where our group were less convinced was the idea of ‘beds and sheds’ taking a leading role in the UK and Europe for the foreseeable future.
One participant highlighted an area that has been overlooked – retail warehouses. A subsector with sustainable levels of rent due to ecommerce transcending into logistics and often discounted by investors due to the ‘retail’ label. Watch this space.
ESG and the increased pressures from both occupiers and investors to reduce carbon footprint
Most of our participants agreed that the efforts to increase the ESG score has led to little or no positive short-term economic return on investments. With an increased pressure by international occupiers to be carbon neutral across their portfolio, it is clear that demand is being driven from all angles across end-investors, occupiers, and local municipalities for more environmentally responsible buildings. Regardless of its commercial application, institutional capital must factor this as part of any acquisition.
However, this view was challenged by what one participant was seeing in the UK market. From his viewpoint, UK occupiers were not prepared to pay a premium for ESG implementation. For example, out of two similar buildings, one costing 25% more in rent because of the fit out, most tenants will go for the cheaper option in terms of real estate. The reality is, most occupiers will take value ahead of specification.
Whilst environmental considerations are currently 90% of everyone’s focus when it comes to ESG, it is becoming increasingly clear that there is an ever-increasing need for social impact from investments. As the market moves to automation and further job losses, the discussion will likely shift the scales towards social impact on municipalities and how the developments can better enhance the lives of the local community.
Brexit, the positive and damaging effects it will have on the sector
With Covid-19 taking centre stage over the past year, it has been easy to forget the tensions caused by Brexit and its impact on the UK and European commercial real estate market. It was felt by our group that the impact on UK and European logistics may not be as hard as on other sectors. With time to plan for a hard-Brexit and manufacturers increasing inventory in Continental European hubs to avoid supply chain hold-ups from Asia, there is less concern on future demand and availability of goods. The greatest impact will be felt on currency hedging for non-UK investors as volatility works its way through the transition. Occupiers have had plenty of time to plan for Brexit, whereas Covid-19 came abruptly. The UK is considered a well developed and significant market, with strong demographics and continued demand for goods.
In conclusion, the momentum in this once quieter sector is set to continue to grow. With short-term lack of supply and ever-increasing interest from capital, this is a sector enjoying its moment in the limelight Whilst there are several challenges on the road ahead, it will be fascinating to see how the sector navigates further pressures on environmental and social considerations, as well as its ability to grow in ever increasing dense urban population centres.
Thanks to our guests for a fascinating discussion.