European logistics real estate — a sustainable growth story

Asset classes well into their stride of outperformance are an age-old conundrum for investors: capture the opportunity or stay on the sidelines? 

The European logistics property sector is one such asset class firmly on investors’ radar due to its unprecedented growth rally that continues to be fuelled by the fallout from the pandemic.

This was the focus of a recent Pan-European Logistics Conference hosted by Investec Property Fund. The conclusions reached by industry experts provide compelling reasons to jump in.

“It’s a fantastic time to be involved in European logistics. Almost all the metrics are at record levels, be that demand, vacancy rates, rents and yields, with the strong market fundamentals and tailwinds looking set to continue,” said Tom Waite, executive director: EMEA Logistics & Industrial Capital Markets at property consultancy company JLL.

With that bullish introduction as the baseline, can things get any better? There are fundamental, fascinating reasons to believe they can.

E-commerce has reached a tipping point

The trend towards online shopping in Europe has been supercharged by the pandemic, with e-commerce warehousing space trending upwards from about 2% in 2009 to 12% on the eve of the Covid-19 outbreak. By the end of the second quarter of 2021 that number had rocketed to 24%, said Waite.

It’s a trend that looks set to continue, said Eric Jansen, managing director of global real estate investment bank Eastdil Secured. “We estimate that an additional 230-million square feet [about 70-million square metres] is needed over the next five years to satisfy supply chain reconfiguration and e-commerce growth.”

E-commerce, however, is not the only factor stoking demand for European logistics space.

More demand is likely to stem from the revenue-enhancing automation that New-Age logistics properties offer their tenants, said Charles Pease, head of Real Estate: Europe at global logistics company GXO Logistics. “By automating a customer’s facility, we can increase their revenue by three to 10 times.”

The “problem” with all this demand is that there’s little floor space left in Europe to absorb it.

In short supply

In addition to a lack of land, there are several other factors crimping stock.

Here’s a more comprehensive list:

• Record low vacancies: Midway through 2021, European logistics property had an average vacancy rate of 4.5%, the lowest on record.
• Zoning issues: Authorities and lobby groups perceive logistics and warehousing as environmentally and socially undesirable and therefore often oppose applications to have available land zoned for development.
• ESG demands: Investors and customers alike are increasingly moving towards greener supply chains. That requires greater capital expenditure and time to bring suitable logistics property to market.
• Labour shortages: Warehouses endowed with automation and tech need more employees with technical expertise, the likes of which are proving difficult to find, adding to leads times, said Pease.

Three reasons not to miss the investment opportunity 

Astute investors would be forgiven for reading about supply shortages and thinking they’ve missed the boat. But the overriding message from the conference was that the existing market dynamics are sustainable and the investment thesis intact.

For SA investors, there are three good reasons supporting that claim:

1. Rental growth 

A sustained shortage of European logistics stock will manifest in higher rental income for the property owners. According to a slide in Waite’s presentation, rental growth in the European logistics market is forecast to grow by 4% a year.

2. Hard currency yield plus compression

Global equity market valuations are elevated, while developed market bond yields remain negligible. Compare those options to the asset class in question, which is generating resilient cash flows, paying mid-single digit yields in hard currency, and is backed by physical assets.

That’s a tantalizing proposition for SA investors wanting to diversify offshore. What’s more, the panellists believe there’s scope for current yields to compress further, resulting in capital appreciation.

3. Investment momentum gaining

According to Jansen, there is roughly $360bn of capital seeking a home in the global real estate market. Using leverage of 65%, the figure tops $1-trillion. With uncertainty still hanging over the fate of the office sector, logistics property looks set to absorb more than its usual share of that investment pie — a boon for prices.

Given the weight of money that’s chasing the sector and a slew of new entrants, Paul Rodger, managing director: Europe at Urban Real Estate Partners (UREP), a specialist logistics and light industrial asset management platform, said there are a lot of risks being taken that perhaps aren’t fully underwritten.

“I think our USP, if you like, is to properly price the risk and the opportunity to unlock it,” said Rodger. “So, while that price arbitrage is definitely reducing, I think there are still opportunities for us as a collective business across the regional markets to create value in it.”

Darryl Mayers, joint CEO of Investec Property Fund, compared the European logistics opportunity with those in our domestic property market during the panel discussion.

“Even though the leverage in Europe is higher than SA loan-to-value ratios (60% vs 30%) with similar 12%-13% internal rate of returns, but [with Europe] arguably at a lower risk profile that you would find in SA, we believe the asset class’s traction warrants the higher gearing.”

Mayer’s co-CEO, Andrew Wooler, said: “The [European logistics real estate] market is very competitive, very transparent, but also very stable. What makes it so exciting for us over the next three to four years, is that we think the earnings line will start to catch up with the valuations line on the balance sheet.”

Will demand continue to outstrip supply?

“Not a week goes by where a large European e-commerce or third party logistics tenant doesn’t talk to us about their struggles of finding good assets, or even just usable ones,” said Jansen.

The question investors need to answer is whether those same tenants will still be struggling to find space in the months and years to come. The demand for European logistics space has a structural character to it in that e-commerce penetration is gaining momentum from a relatively low base. The ancillary factors boosting demand all have robust merit, too.

SA investors who gain exposure to European logistics property today won’t be getting in at the bottom. If demand keeps its nose in front of supply, which on balance seems likely, rental growth and the concomitant compression in yields will provide further impetus for returns.

In conclusion: the European logistics real estate sector is the place to be in 2021, and it looks set to continue into 2022 and beyond.

This article was paid for by Investec.