This article is sponsored by ESR.
Logistics real estate markets across Asia-Pacific have reacted differently to the coronavirus pandemic, but a number of themes have held true across geographies. The advancement of e-commerce has accelerated, while the sector has become a favorite for investors and competition for land is fiercer than ever. Jeffrey Shen and Stuart Gibson, co-founders and co-chief executives of listed Asia-Pacific logistics real estate specialist ESR, consider the outlook for their different markets and the long-term position of logistics real estate.
What has been the overall effect of the covid pandemic on APAC logistics real estate?
Stuart Gibson: Logistics has been on the ‘right’ side of the pandemic and it has turbocharged the trajectory logistics real estate was on anyway. The shift from bricks and mortar to online shopping has accelerated and that has been the same across markets, regardless of how far e-commerce had penetrated prior to covid.
Jeffrey Shen: There was uncertainty early last year as no-one knew much about the virus and a small portion of our development plans were delayed, first in China and then elsewhere. However, the disruption was minimal and development activity soon picked up.
This was especially true as it became clear that logistics was one of the areas essential throughout the pandemic to support the daily life of our cities and in fact demand has substantially increased because of the shift to online. This supported strong leasing activity and development starts for the year overall.
Does investor appetite for logistics real estate remain strong and will it continue to compress cap rates?
JS: We see momentum accelerating as institutional investors are willing to allocate more capital to this sector. The interest rate trend was already downwards, and this will continue even longer than expected. For logistics development you really need a platform, but we are seeing investors re-allocate capital from other sectors to logistics, which will add to pricing pressure on stabilized assets.
SG: Logistics is classified as real estate, but I have always thought of it as infrastructure for the new economy. For that reason, I don’t see logistics as being susceptible to the vicissitudes of the capital markets and other real estate asset classes. For example, in the GFC, rents for offices in Marunouchi, Japan’s premier business district, halved in three months. Meanwhile, logistics warehouses saw little impact.
The flip side, of course, is that you don’t see rapid rental growth when the economy is racing. So, a lot of institutional investors love logistics because it’s very, very steady. It’s easier to forecast and has more resiliency.
In some markets you now see that logistics yields are lower than office yields, which reflects the stability of income that logistics investment offers. You have longer term tenants who take larger chunks of space – far more secure than a multi-let office building. Coupled with cheap debt, I think this means there is further to go. Looking at Japan for example, I think you will see logistics cap rates at 3 percent this year.
Japan is one of ESR’s biggest markets; how did it fare in 2020?
SG: There has been a huge surge just in the demand for space in the last two quarters and in the adoption of online shopping for Japan. Previously, it was really lagging behind China and Korea in this respect. Now, a whole new generation of people have turned to online shopping and they are not going to go back.
As a result of this new demand, 2020 was a banner year for leasing for us, with 750,000 sq m, nearly twice 2019’s figure. We were signing leases with blue-chip tenants such as Amazon on a monthly basis and are now one of the biggest e-commerce landlords in Japan. On average the leases we signed were for rents 10 percent above our underwriting.
Land remains the significant factor in Japan; it accounts for around 45 percent of costs, compared with 20 percent elsewhere, and in Tokyo, land will account for more than half your costs. Those land costs are rising as competition intensifies.
There is a relatively small number of specialist logistics developers in Japan and some larger local companies who cycle in and out of the sector. However, due to the impact of the pandemic on other real estate sectors we have seen a lot of new entrants, which has sent prices upwards.
We try to stay out of land auctions as they are most susceptible to market exuberance, therefore we prefer to focus on larger multi-phased parcels which can be developed over several years, in some cases we even work on rezoning projects which not many of our competitors have the patience or competence to do. This tends to whittle down the competition.
How about China?
JS: China leasing was relatively weak during 2020’s post-Chinese New Year shutdown, but it recovered very quickly and accelerated throughout the year as the economy returned to normal levels. Apart from e-commerce and 3PL, which account for around 60 percent of our tenant portfolio, we have seen a growing demand from food-related tenants. Construction was hampered initially, but we were able to resume after a few months.
Investors were very cautious early in the year due to the uncertainty which prevailed, but their confidence in logistics returned very quickly and very strongly and they started to allocate more capital to the sector from the end of Q2 2020. Now that China’s economy is back on track and growing strongly once more, I expect to see more demand from both tenants and investors.
Korea escaped relatively lightly from the pandemic. How is logistics real estate doing?
JS: Overall demand recovered and has been maintained in Korea, which was already one of Asia’s most developed e-commerce markets, and we are seeing a lot more interest in logistics. We have a dominant position there, especially in terms of developing new space as we have an industry-leading development pipeline. We are also seeing a lot of new players looking to enter the market which will make it very interesting and be good news for existing modern logistics assets.
SG: We are really proud of how things are working out on Korea, in particular getting ESR Kendall Square REIT launched just before Christmas. It’s the first institutional grade logistics REIT and we saw overwhelming demand from both domestic and international investors.
Are the prospects very different for ESR’s businesses in Asia’s developing markets?
SG: India has obviously taken a big hit from the pandemic and we are still getting back up to speed with the construction sites there. Once we are on the other side of covid, the long-term prospects for India are substantial, with its size, demographics and growth trajectory.
We have been proactively exploring opportunities in new markets. There’s no point in us waiting until these markets are a bit more mature and a bit more developed because by then, if you wait another three or four years, it’s probably going to be too late, so you just have to be there early and take a longer-term view.
What developments do you expect to see in APAC logistics real estate in 2021 and as we emerge from the pandemic?
“Japan is leading the way in approving the use of unmanned commercial drone flights, with drone corridors planned for Tokyo and Osaka”
SG: We will continue to see more technology come into this space. China is ahead in this regard, with many warehouses almost completely automated, however Japan is far behind, but with its demographics, automation is necessary.
Surprisingly, at least from a regulatory perspective, Japan is leading the way in approving the use of unmanned commercial drone flights, with drone corridors planned for Tokyo and Osaka, and we are working with drone developers to ensure we stay at the front of this potentially game-changing trend.
Our Higashi Ogishima development in Kawasaki, near Tokyo, will have a drone port on the top floor. This is going to be the world’s first cargo drone facility, setting new standards and opening a new chapter for logistics infrastructure.
JS: We are always looking to create more opportunities for our investors and tenants so we are exploring related sectors such as cold storage, where demand is growing strongly and data centers, where our land sourcing capability and our existing portfolio can be put to work for another in-demand sector which – like logistics – is serving the digital economy.
“With or without the pandemic, there is further momentum for the expansion of logistics infrastructure in Asia”
SG: It is a sector which has synergies with industrial development. For example, land sourcing, design and construction skillsets are transferrable from our logistics development business. The tenant side is quite different, not least because you are effectively selling them power rather than renting space. We have plans for data centers in a number of markets and the next stage is to decide where it sits within the ESR platform.
JS: With or without the pandemic, there is further momentum for the expansion of logistics infrastructure in Asia. Having good local teams around the region means we can see the supply-and -demand dynamics in each market and there is still a very big gap in most of the countries in Asia over the long term.
The continued move from offline to online business will continue to drive demand. Also, many manufacturers and logistics companies are now trying to build more flexible and resilient supply chains, which will drive more demand for space.
Sourcing land will continue to be a major challenge across all markets and the only way to meet that challenge is by having good teams on the ground who understand the areas where they are sourcing land and are familiar with the local authorities and businesses. You also need patience to assemble larger sites.