This article is sponsored by ESR. It appeared in the Investing in Logistics and Distribution supplement with the February 2019 issue of PERE magazine.
Formed in 2016 by the merger of the e-Shang and Redwood groups, ESR operates in six Asia-Pacific markets and has a portfolio of approximately 11 million square meters of gross floor area across the region. In the past 12 months, ESR has welcomed Chinese e-commerce giant JD.com as an investor and launched two joint ventures: a Japan core vehicle with AXA Investment Managers – Real Assets; and an India partnership with Allianz Real Estate. Co-CEO Jeffrey Shen talks to PERE about what’s driving the logistics business in the firm’s core markets and how investor interest in the sector is developing.
PERE: Tell us what’s driving the logistics real estate business in China, Japan and South Korea.
Jeffrey Shen: In China, demand in the last seven to eight years has come largely from retail, especially from e-commerce. And if you look at some of our largest customers in China right now, you’ll see the names of top e-commerce players such as JD.com, Cainiao, Vipshop and NetEase. The total volume of domestic consumption is very close to that in the US, but it is growing at 9-10 percent a year, so there is enormous potential still.
In Japan, e-commerce growth has begun accelerating, but is still behind China where digital consumption is around 20 percent of the total, compared with under 6 percent in Japan. With only about 5 percent of logistics capacity being modern, in Japan there is robust demand for modern logistics facilities to replace older, smaller warehouses. An important difference between the markets is that in Japan, retailers generally do not do their own logistics, so our major customers are domestic third-party logistics (3PL) companies. Korea is similar to Japan in that e-commerce is growing and that 3PLs dominate.
PERE: In which cities in China, Japan and Korea are you seeing the most logistics demand from tenants?
JS: For manufacturing logistics in China there is demand in all the big cities. However, for logistics serving domestic consumption, demand is focused on the first-tier cities of Beijing, Shanghai and Guangzhou. One of our e-commerce tenants recently estimated that more than half its business comes from these cities. In Japan, the most active cities are the three traditional metropolitan areas of Greater Tokyo, Greater Osaka, Greater Nagoya whereas in Korea it’s all about the Greater Seoul Area, which is home to half the country’s population.
PERE: What about the logistics real estate itself, how does the warehousing you develop differ between markets?
JS: Across our core markets you can see three generations of modern logistics space. The first-generation China warehouses were US-style big boxes with around 9.5 meters height. Now in China we see more second-generation facilities, such as multi-story buildings with a ramp, as you might also see in Japan and Korea, where the land cost is higher.
As the industry continues to evolve, two features are getting more and more crucial for prime logistics facilities: automation and human-centric design.
In China we are starting to build third-generation warehouses, that is multi-floor facilities with high-density storage equipment, to accommodate automation and robotics. We are seeing more demand for automation due to rising wages and the need for maximum efficiency.
In Japan, we put much effort in bringing a human-centric design to our warehouses. For example, we created the BARNKLÜBB, a day-care center offering childcare services, to help encourage women to re-enter the workforce. We also have the KLÜBB Lounge, a well-equipped lounge for employees to relax.
PERE: ESR has also been expanding into new markets: Singapore, Australia and India. What’s driving these new ventures?
JS: Singapore is a major market for REITs in Asia and we had an opportunity to become a REIT manager there with Cambridge Industrial Trust, which is now ESR-REIT. Last year we also took the opportunity to expand by merging ESR-REIT with another REIT, Viva Industrial Trust. Although Singapore is a smaller logistics market, it plays an important strategic role, in particular from a capital perspective. Having a position as a manager of Singapore REITs has great value for us, with regard to potential future vehicles.
Australia is an important market in our regional growth strategy. Similar to Singapore, there are assets and platforms available. After our strategic investments in Propertylink and Centuria, ESR bought Australian developer CIP.
We intend to leverage CIP’s land bank and development capability to seed a new funds management platform.
We see strong interest from our capital partners in India and have built a great local team in Mumbai. India is like China 10-15 years ago with a lot of new development to serve manufacturing that is moving to India and to serve growing domestic consumption. E-commerce is at an early stage in India but growing. We launched the India business in 2017 and already have approximately 700,000 square meters of developable GFA and a robust pipeline of projects in prime locations across tier-one cities.
The ESR network has been growing hand in hand with our tenants and capital partners as they expand and thrive in Asia-Pacific. Our network of modern logistics facilities and investment vehicles provides good regional synergies for them.
There’s interest from customers and capital partners in other potential markets in South-East Asia – Bangkok, Jakarta and Ho Chi Minh City, for example – so we’re always exploring opportunities in both developed and developing markets.
PERE: What are investors looking for in logistics real estate and how are they allocating capital to the sector? What sort of returns do investors expect?
JS: There is a somewhat different approach depending on whether we are talking about international or domestic investors. International investors continue to show a strong interest in this sector across the region, and very often they are looking in at least two or three markets in Asia. For example, one of our long-term investors, APG, is a capital partner in both China and Korea.
For domestic investors, Korean investors are similar to their international peers that they are keen to diversify their exposure in various Asian markets.
In China, investors such as insurance companies, are increasingly interested in holding local logistic assets because of the stable cash dividends and their expectations in rising land values and rents.
We’ve been able to attract leading institutional investors – both international and domestic – because of our development capacity and our relationship with tenants across multiple geographies. Moreover, we have a network that allows us to take advantage of growth opportunities in various markets at different stages of the investment cycle, and provides flexibility to our capital partners to deploy their capital across different geographies and risk profiles via different types of funds and investment vehicles.
The typical return expectation for the development funds depends on the market. For instance, in China investors might typically expect a 12-15 percent IRR for a development fund and a high single-digit return for a core fund.
PERE: Should we expect to see pan-Asia logistics funds emerge, as we have seen growth in regional core property funds?
JS: There is demand due to the prosperous outlook of the region, and that there is a natural hedging effect among the countries. However, we need to build the infrastructure for such funds; there are challenges with different tax regimes, different currencies and different political and economic outlooks. You also need to be careful to avoid conflicts with the country funds.