This article is sponsored by Logistics Capital Partners
Since Logistics Capital Partners was founded in 2015, it has focused almost exclusively on build-to-suit and pre-let projects. In the last 24 months, however, the company has taken a deliberate shift into speculative developments. Co-founders James Markby and Kristof Verstraeten tell PERE why they see opportunity in this space and how they are maintaining a strategic balance between build-to-suit and speculative.
Why shift strategy from build-to-suit projects to speculative development?
Kristof Verstraeten: For the initial plan we were focused on a number of corporate customer relationships and build-to-suit projects, as it was relatively easy for us to enter new markets through established existing customer relations. As we developed and grew our team in a new market, we became more embedded locally, which allowed us to look at other business areas not purely dependent on pan-European customer relationships.
This more recent gradual process has opened the door to a complementary local strategy that includes the acquisition of speculative land positions and the corresponding speculative developments with our balance sheet partner, Invesco, with projects near Brussels, Turin, Madrid, in the Netherlands, and most recently, in Cremona, south of Milan.
A second element is an interesting niche market that is opening within logistics: the really long-term developments. These are typically very large projects, with so much land that it could take between five and 10 years to fully develop them.
They could also be complicated developments, like city reconversion urban logistics projects, with a complex process of permitting, demolition and a long period of reconstruction of a multilevel logistics building. As we have expanded our teams, we are seeing these good opportunities in the market.
The third piece is the capital. These projects require longer-term capital, as you are basically investing with a five-, 10- or even a 15-year horizon.
Thanks to the availability of this source of capital, which is broadening our investor base, and the strengthening of our teams locally, we can access a whole range of new projects to work on. A recently completed example of this is 15 acres of brownfield redevelopment adjoining Heathrow airport in London with our most recent partner, Oxford Properties, who we can also co-invest alongside.
“These projects require longer-term capital, as you are basically investing with a five-, 10- or even a 15-year horizon”
This represents potentially £150 million ($204 million; €168 million)of development, with commencement three to five years away. We have others like this which are also being progressed that are significantly larger and longer term, also in the UK and in other major cities such as Paris.
Why does speculative development make sense in today’s market?
James Markby: There’s a clear continuing and growing occupational need – both in terms of demand of space and take-up – all over Europe. On the flip side, there is a shortage of supply in pretty much every main market, with less than 4-5 percent availability of grade-A space in several markets. So, that is the perfect recipe in our evolution from 2015 for deciding to take a bit more risk, a measured risk with a nice blend of activity, and produce speculative inventory buildings in markets where we see that opportunity.
Whilst there’s continuous demand for build-to-suit, which can require two years to deliver, often we have requests saying, ‘We want to consider that for the future, but what do you have for us to take within three to six months?’ When you have been asked that kind of question all the time, that’s a very obvious signal that you need some spec in your portfolio.
On the capital market side, logistics has been the top-performing sector for several years now, both on an income and yield compression basis, so there’s a huge demand for every type of logistics asset across every country. A growing number of investors, including core capital, are more prepared to take a little bit of extra risk to be able to access the market.
They also see the dynamics on the occupational side, which encourages them to take that risk and see it as a lesser risk.
Which type of investors are demanding access to development strategies?
KV: There’s a shift from higher-risk hedge fund or private equity capital towards longer-term pension fund and insurance capital taking positions on long-term, large development projects.
JM: We are also seeing Korean capital being interested in the development and funding side, which is new. As these typical core investors enter the development space seeking higher returns, it requires their teams and committees to have a more agile and problem-solving attitude to deal with the realities and fluidity of development projects.
Ironically, rather than project-level development risks, the biggest risk can sometimes be institutional capital counterparty risk. Development projects are constantly changing and if your capital can’t follow on these developments as they evolve, you cannot move with the project. This is why we are trying to create long-term, profound relationships with our capital partners, where we can really trust each other to solve things quickly, and to then do a range of development projects and portfolios to suit them. Our Invesco relationship is a very good example of that.
What is driving investor appetite?
KV: When you do development there’s an associated profit margin, a value creation that happens by creating the product. But the second component is how long you hold the finished product afterwards. The longer you hold it the more you spread that initial margin over that longer holding period.
The type of projects we are looking at right now are actually projects to develop and hold over a longer period. For a pension fund or insurer, one of the key motivations is to own these products long-term, and also to know that their value creation is not purely a function of compressing market yields (in a market where a lot of that has already happened).
We think longer term this is a stronger fundamental cyclical position for them, and for LCP, compared to many other propositions, of which many seem to solely focus around a new logistics ‘brand’ creation through asset aggregation late in the cycle.
Today, it’s really tough to purchase these long-term hold assets because few are selling them. And when you buy them, these buildings are, relatively speaking, expensive. By stepping into development, and having a development component over a 10-year horizon, you can effectively up your returns by 100 or 200 basis points, or sometimes even more.
JM: Our secured pipeline illustrates investors’ appetite and our speed of growth. In 2018, we had a pipeline of 11 million square feet; that moved to 14 million square feet in 2019 and, at the end of 2020, we had a pipeline of 19 million square feet. That moved from a 90:10 split between pre-let and speculative work to more like 50:50 now, while continuing to also grow the total square feet of pre-let in real terms, so one hasn’t been to the detriment of the other.
In terms of the capital requirements, we estimate that developing 19 million square feet requires around €1.5 billion of debt and equity. In a five-year program, that allows us to produce an order of magnitude of say €2 billion of grade A, brand new logistics buildings across the countries we operate in (with a further €1 billion with a longer-than-five-year phased time horizon), all of which allows us to continue to significantly enhance our balance sheet in a relatively short period again.
Is co-investment gaining traction in the sector?
JM: There’s always been a requirement for co-investment but when we started, due to the nature of our start-up balance sheet, we were limited. That has changed after five years of development and we’ve grown our balance sheet and profits while we keep rolling and re-investing. We have now a greater capacity to meaningfully co-invest, which changes the type of investors you can go to with material co-investment.
This also allows us to become more competitive in an increasingly expensive market. By using co-investment and gained profits over previous years, you can improve your cost of capital and competitive position. That’s again part of the structuring we’ve been putting in place over the last 24 months.
KV: It gives confidence to the investors but at the same time we put our own capital at work without having to invest entirely with our own capital, so we can do 10 projects in which we need to co-invest 10 percent, rather than doing one project. Still, we get our own capital invested as well, so it’s a win-win. And that is very much a trend in the sector, and both sides – developers and investors – want to work that way.
Where do you see opportunity for developments across Europe?
JM: We see opportunities in each of the seven countries where we are present. We have both new spec and build-to-suit projects, typically now on a 50:50 basis in each of those markets, so we see a need in all of them. We started our activity to serve the obvious major cities and capitals in Western Europe.
These locations were a natural place for us, and also occupiers to start. But as occupiers build their network, they start to increase the intensification and efficiency of their supply chain in regional markets. That’s where our build-to-suit activity takes interest, particularly in Spain and Italy, with obvious regional markets and build-to-suit requirements, as they are completely undersupplied and harder to access. That combination of spec and build-to-suit spread between core capital cities and regional markets helped us to keep the right balance, with spec activity in the core locations and pre-let in the broadening regional locations.
How do you expect market conditions to change this year?
JM: All the positive underlying dynamics – increasing e-commerce, higher demand from occupiers and capital, a growing environmental and sustainable agenda that is creating demand for new buildings – these tailwinds are long-term structural shifts and will continue for the next year. The biggest challenge is continuing to ensure our business is structured and designed to remain competitive in an increasingly expensive and competitive environment with more and more capital coming in.
“Increasing e-commerce, higher demand from occupiers and capital [and] a growing environmental and sustainable agenda… will continue for the next year”
KV: There are also a few obstacles right now. One of them is the scarcity of land and corresponding regulation and complexities for permitting. That pushes you towards more complicated things like brownfield developments.
Another challenge is covid related. Especially for an organically-grown private business like ours, it’s more difficult to recruit people for our platform and integrate them into a team when you can’t meet face-to-face. We look forward to an end of lockdowns so that we can go full steam ahead again on recruiting and expanding the team.