Logistics had been making steady progress over recent years, but growth in 2020 was phenomenal. The key trends underpinning the sector’s success remain in place for 2021 as warehouses have truly moved to center stage.
Investors were clued in to the rise of logistics before covid-19 struck. That ascent was largely driven by the inexorable rise of online shopping. If that was true before the pandemic, e-commerce is on another level already. Market participants concur that one effect of the crisis has been to condense several years’ expected growth into just 12 months.
The pandemic has underlined the importance of logistics, and the real estate asset class has proven its resilience. From here it appears poised to move from strength to strength.
The UK market provides one clear example. Take-up of UK logistics space in 2020 exceeded the amount for any other year on record, according to CBRE, totaling 42.97 million square feet – 69 percent higher than the figure for 2019.
Q2 and Q3 each broke records for logistics take-up, before Q4 totaled more than 10 million square feet, almost double the quarterly average. This is a real estate juggernaut that is not slowing down.
Logistics is on the rise just as other asset classes – not only retail, but offices, too, as working from home becomes normalized – are struggling. The stage is set for logistics to become the prime core asset of the future. There are a number of important trends to be aware of as logistics comes to the fore.
Logistics is hot property
Industrial investment volumes overtook retail for the first time in 2019. Few would bet on retail reversing that any time soon.
Last year, logistics remained the third-most invested real estate asset class, behind office and residential. It accounted for 20 percent of all global property investment in H1 2020.
Rental rates increased, absorption remained positive and cap rates were flat, with developers, owners and operators seeing demand for a wide range of space – whether big boxes of 1m-plus square feet or small, last-mile centers.
“Investors globally remain underallocated to the real estate asset class and industrial continues to benefit from this weight of capital,” says Michael Lisa, vice-president at Hodes Weill.
“If you just compare offices and logistics for what they’re offering in terms of income, then logistics is looking more attractive at the moment, which is why we’re seeing so much interest from investors,” says Marcus de Minckwitz, regional investment advisory director for EMEA at Savills. “Logistics is rising to the top as the most desirable, the most secure, the most stable income product.”
However, there almost certainly is not enough logistics real estate to go around for it to become the backbone of institutional investors’ portfolios. A portfolio can load up on offices, but logistics is not an asset class that lends itself so easily to making up the bulk of a book.
That is not true for everyone, however. US-based property manager Clarion Partners had, as of Q3 2020, €22.4 billion of assets under management in logistics compared with $10.2 billion in office assets.
Tim Wang, head of investment research at the firm, sees office’s crown as there for the taking. He says: “Portfolio allocation weighting in the office sector has declined steadily over the past several years and this trend will likely continue over the next few years.”
Industrial has to do more than ever
When is a shed not just a shed? Logistics real estate has come a long way.
Palmer Letzerich, senior managing director and head of the industrial and logistics platform for the US south-west at Hines, says: “Tenants and landlords are asking these buildings to perform more activities and to be more flexible today than ever before, and I see this trend continuing over the coming three to five years.”
A major change we have all seen is distribution direct to the consumer. Michael Levy, CEO at Crow Holdings, does not see trends such as this reversing when the coronavirus crisis has dissipated.
“My 90-year-old father had never used Amazon before the pandemic, and now he cannot believe what a fabulous tool it is,” he says. Levy expects the secular trends underpinning e-commerce to continue to drive the industrial sector, with the demand needs in the space proving overwhelming
as a result.
The experience of 2020 has shifted attitudes to online shopping, and customers are only becoming more demanding.
Letzerich says: “Tenants are servicing will-call and pick-up applications; storing by destination and frequency of throughput in addition to category of product; and using the buildings as training centers for their employees.”
As tenants use their buildings differently, they have different requirements of them. Levy notes: “Fifteen to 20 years ago, you might have had a million square foot building with 30 people working in it. Today, many of those buildings are fulfillment centers where you have hundreds of employees who need a place to park, a place to eat, a place for breakout facilities and other amenities.”
They may also need a drone port.
David Roth, head of US real estate equity at Ares Management Corporation, notes that e-commerce sales increased 32 percent in Q2 2020. The slice of total sales through e-commerce could exceed 30 percent by 2030, he predicts.
It is impossible to examine e-commerce without touching on Amazon, and the e-commerce giant is once again at the heart of developments. Amazon Prime Air, set to use drones to deliver packages, could be a major disrupter.
“The development of this technology hasn’t been seen before,” says Roth. “Over the long term, that may have implications for tenants’ needs to upgrade their facilities.”
In Japan, which ESR co-founder Stuart Gibson picks out as leading the way in approving the use of unmanned commercial flights, there are drone corridors planned for Tokyo and Osaka. The firm’s Higashi Ogishima development, near Tokyo, will have a drone port on the top floor, understood to make it the world’s first cargo-drone facility.
Technological advancement is continuing apace. China is a leader in automation, although, again, Japan is not far behind.
Sheds are versatile
There is more variety to logistics than some investors realize. Two particularly noteworthy subsectors are urban farms and, perhaps most pressingly during the pandemic, cold storage.
Hydroponics farms, often with tray upon tray vertically stacked, could go a long way to solving food production issues around the globe. Peter Bretveld, senior portfolio manager at Kempen Capital Management, says: “The pandemic demonstrated certain weaknesses in the food supply chain. In the early stages especially, countries struggled in getting supplies of good quality food, particularly in developing countries.”
But it is not just in developing countries. The largest vertical farm in Europe is in the UK, fitting 17 layers into a 12-meter floor-to-ceiling height. Singapore, suggested as a post-Brexit model for the UK to follow, also happens to be heavily invested in vertical farming. By 2030, the city-state aims to produce 30 percent of its nutritional intake domestically, with hydroponics farms playing a crucial role in achieving that.
Singapore’s interest is strengthened by the events of last year, when the pandemic disrupted logistics networks all over the world and stores were left with empty shelves. Food security fears are also real in many other countries that feel a need to cut down on their reliance on importing food.
There has been $2 billion of investment into vertical farming since 2014, but it remains niche and – so far – unprofitable. These are early days, however, and if 2020 has taught the market one thing it is how quickly change can come.
Peter Day, asset manager at Oxenwood, is “under little doubt” that hydroponics farming will become a “major new trend.” ESR’s Gibson “can definitely see” urban farming happening and says that over the next decade he would be surprised if some percentage of warehouse space was not being allocated to urban farming.
Another growing part of the logistics supply chain is cold storage. This is a niche that was previously dominated by specialists and owner/operators, but it has seen substantial growth in demand as real estate investors see value in supplying it.
Cold storage is not just for food, although that is a large part of it. The pharmaceutical industry is another major user of cold storage space. Demand for covid-19 vaccines will drive even greater demand for freezer space.
Nuveen Real Estate has invested in food and pharmaceutical cold storage, while PGIM formed a joint venture with Bridge Development Partners in December 2019 to acquire and develop US cold storage assets.
“The increase in consumer utilization of online grocer services [accelerated by the pandemic] is expected to add to future demand within the cold storage subsector,” says Darin Bright, senior portfolio manager for PGIM Real Estate’s US core-plus strategy.
Painting it green
Although vertical farms are energy-intensive, they also use considerably less water than their traditional counterparts. Such green considerations are not unfamiliar to logistics real estate market participants.
ESG is a particularly hot-button issue in Europe, a continent where development land is particularly hard to come by. As ESG standards are raised higher and higher, that is going to make a number of buildings obsolete, thus requiring redevelopment and value-add investment. For an operator, however, it is worth doing. When a tenant can make savings by taking a more efficient building, it will be more willing to sign a lease at a higher rent. “For modern, low-emission assets there is plenty of transactional evidence that they are highly liquid and command prime yields,” says Lorenzo Caroleo, Italy head at Cromwell Property Group.
Both customers and investors are demanding environmentally friendly solutions, notes Robert Dobrzycki, chief executive at Panattoni. He believes that any asset which does not take that into account has a pricing discount attached.
“When you start to hear the biggest global investors say they will not invest in anything which is not environmentally friendly, that has a direct impact,” he says. He notes that ESG is the difference between letting and not letting a building.
GARBE Industrial Real Estate co-managing director Jan-Dietrich Hempel notes that investor pressure is intense. “It is the demands of our increasingly pan-European and global investor base that are the strongest driver for building certification, sustainability and all other aspects of the ESG agenda,” he says. His firm is positive about the merits of the GRESB benchmark. Although BREEAM, LEED and others all have their place, and GARBE does seek certification from them, Hempel notes that GRESB in particular recognizes that improvement is a process and provides credit for improving performance in a step-by-step manner.
Logistics Property Company chief executive Jim Martell notes that ESG is far from a uniquely European concern. Nor is it the only consideration when it comes to doing what investors and customers might consider “right.” His firm is also focused on diversity, equity and inclusion.
Although there are plenty of facts and figures to back up its DEI work, the 3711 South Ashland Avenue, Chicago facility that LPC unveiled last year is a striking example. The modern warehouse has a mural by a female multi-disciplinary Detroit-based artist, who collaborated with several local and Midwest artists, along one wall. This is not just beautification for its own sake – it also deters graffiti and adds value to the building.
Nevertheless, sustainable development remains a prominent factor for the asset class and examples of best practice construction are proliferating. One notable in that regard is Magnitude 314 in Milton Keynes, UK. Claimed to be the world’s first building verified net-zero carbon for construction, GLP’s warehouse achieved such a distinction through measures such as low-carbon concrete mixes, use of recycled materials and maximizing structural efficiency.
There’s a lot more to come
With logistics real estate proving its adaptability, not to mention its resilience in the face of a trying year, it is of little surprise to see it expanding rapidly and funds in market are looking to join in the action. The largest industrials fund in the market as of January 1, 2021 was Exeter Property Group’s Exeter Industrial Value Fund V, targeting $1.6 billion to invest in the US.
Of the 10 largest funds in market, only one other has a North American regional focus. That vehicle is Dermody Properties’ $800 million Dermody Properties Industrial Fund III, which opened in 2020. Four of the top 10 funds have a European focus, while four have an Asia-Pacific focus. Of the vehicles with a European focus, Prologis’s $1.35 billion Prologis UK Logistics Venture has a UK focus, while BEOS’s $1.34 billion BEOS Corporate Real Estate Fund Germany IV has a Germany focus.
Two of the Asia-Pacific funds – China Life Investment Holding Company’s $1.3 billion Logistics Warehousing Fund and LOGOS’s $800m LOGOS China Logistics Venture 4 – are targeting China, while the other two are both targeting Australia.
PERE tracked 52 logistics funds in market as of the start of the year. Of those, 17 have an undisclosed size.
Among those with a disclosed target size, there is a clear weighting in favor of the belief that bigger is better. Half a dozen vehicles have a target size of more than $1 billion.
At the same point a year earlier – on January 1, 2020 – there were only four funds in market with a target size of over $1 billion. Although there are 18 this year looking for between $250 million and $1 billion, last year there were 13 that fell into that bracket. The most-favored strategies are core-plus and value-add, with funds targeting $6.2 billion and $4.8 billion, respectively. Funds with an opportunity strategy are targeting a comparatively modest $2.5 billion, including two of the 10 largest vehicles. However, these statistics relate to closed-end fundraising only and it should be noted that much logistics property fundraising happens via open-end vehicles or publicly listed vehicles.
Logistics real estate offers a growing opportunity set. Investors appear keen to take advantage.