Lenders still love sheds, but not unconditionally

In the past decade, the once unfashionable logistics sector has become a magnet for investor capital. As consumers swapped shopping trips for online clicks, demand for sheds from e-commerce platforms rocketed, creating an extremely hot market across Europe.

In the first half of 2022, investment in European industrial and logistics property hit a record €31.2 billion, data from CBRE shows. And while Q2’s volume was 8 percent down on the same quarter in 2021, the property services firm says it was still the sixth highest quarter on record.

Debt providers have proved more than willing to finance this boom. For years, they have viewed European logistics as great collateral – a fundamentally undersupplied sector, driven by seemingly unstoppable tailwinds. More recently, concerns about the performance of offices and retail have further encouraged them to funnel capital into the sheds space.

Despite the worsening economic outlook, many remain convinced the sector is generating attractive financing opportunities. Tenant demand, they argue, remains robust. Indeed, CBRE reported 180 million square feet of take-up in the European sector in H1 2022 – an 8 percent increase from the same period in 2021. Average vacancy rates, it added, dropped below 2.5 percent across the top 10 European markets for the first time ever.

Doubts emerge

However, economic volatility puts into sharp focus the debate around whether logistics is a bubble that will pop. And there are signs some lenders’ ardor for sheds is cooling. In the Q3 sentiment survey conducted by property finance industry body CREFC Europe, the index score calculated to track respondents’ confidence in individual sectors dropped into negative territory for logistics for the first time since the quarterly survey was launched in Q1 2019. Some debt providers have also said that, while it is still fine to finance sheds, more caution is required.

There are good reasons for lenders to question their faith in logistics. Yields are incredibly low at a time when interest rates are rising across Europe. In July, consultancy Savills reported a 23 basis-point compression in average prime yields in the first part of 2022, to 4.08 percent. Market participants even report sub-3 percent yields in cases – levels many believe are not sustainable in a rising-rate environment. In its report, Savills made the point that higher debt costs mean prime yields in core markets have reached their nadir, with some softening to be expected.

The cost-of-living crisis and supply-chain disruption may also impact tenant demand. In August, Savills said firms that have invested heavily in inventories in response to supply bottlenecks may reduce inventory accumulation in the coming 12-18 months – a so-called ‘bullwhip effect’. Rising warehouse costs may also impact logistics operators, many of which operate on tight margins. Such factors have the potential to result in slower rental growth in the sector.

Proponents of financing sheds will argue that yield softening and economic challenges for occupiers will not act to significantly derail the performance of the European logistics market – and they have a strong argument given Europe’s undersupply of shed space.

However, an extra degree of caution is warranted for those writing logistics loans. Loan-to-value ratios have generally been conservative across the sector, but with rising debt costs likely to impact asset prices, lenders will need to think carefully about the amount of leverage they are prepared to extend to sponsors.

Asset selection will also be increasingly important. In a hot market like logistics, the distinction between prime and secondary assets can become blurred. Lenders will need to scrutinize the quality of the assets they are considering financing, as well as the strength of tenant demand for the location.

Logistics has been considered a sure bet for several years, but economic conditions will test the strength of the sector. Lenders will keep faith, for now, but choosing the right entry point to a deal is more important than ever.