Logistics remains the star vehicle of private equity real estate investing in 2019. Like a superhero movie franchise, the product keeps getting bigger, more eye-popping and technically sophisticated, and the box office figures go on breaking records.
Last year was not a particularly strong year for garnering capital, but in a shrinking market logistics was the stand-out asset class, dominating sector-specific fundraising for private real estate strategies in 2018 with a total of just over $12 billion, $2 billion more than its nearest sectoral challenger, multifamily residential. Some 43 percent of the $28.66 billion raised for sector-specific funds went to logistics strategies.
Among equity investors, Canada Pension Plan Investment Board (CPPIB) has made by far the largest overall capital commitment to pure logistics funds. For the fund’s global head of real estate investments, Peter Ballon, the sector’s appeal is easy to summarize: “We are always looking for high risk-adjusted returns and in many markets industrial has continued to provide that,” he says.
Olivier Téran, chief investment officer at the real estate arm of European insurance company Allianz observes that logistics remains investors’ most preferred asset class globally. “As a sub-sector, logistics is still far less institutionalized than offices, retail or residential. In addition, the retail sector is moving out of favor in part due to the rapid increase of e-commerce, which in turn leads to a natural expansion of the need for logistics space. Meanwhile, logistics remains attractive on a relative basis to other sectors by a spread of around about 150 basis points, and relative to bonds by about 450 basis points. At the same time, an increase in construction costs combined with historic low vacancy rates is leading to further upward pressure on rents.”
As a consequence, a vast weight of capital is settling on an asset class that lacks the scale to carry it. “Everybody wants into the sector and they want in now,” says Martina Malone, head of global capital raising at specialist logistics manager Prologis. “The main concern for investors is to get their capital deployed as quickly as possible, but the tricky part is deploying in an accretive manner within a reasonable time frame. For example, our European core fund has an equity queue of almost €1 billion.”
In that context, investors are increasingly choosing to back development in order to secure stock and drive returns. Some are forming joint ventures with developers, including CBRE Global Investors, which has established partnerships with Prologis in the UK, Montepino in Spain, and Virtuo in France. “We have clearly moved up the risk curve in that most of our logistics funding is for new development, and our investors are very willing to support that,” says global chief investment officer Jeremy Plummer. “You can acquire the stock cheaper and the leasing risk is relatively low given the very strong demand. You are also acquiring modern buildings, so you are less affected by depreciation of the assets.”
CPPIB is also pursuing development strategies and working through joint venture structures. “There is no doubt that industrial is a very favored sector and a lot of capital from institutional players is flowing into the market, but there is a limited amount of development taking place and not all of that capital has an appetite for development, so the dynamics are still reasonably positive for that type of strategy,” says Ballon.
Tap into consumption
Institutional investors are also looking toward emerging markets to generate higher returns and participate in the growth generated by urbanization and increased consumption. Quebec-based Ivanhoé Cambridge was one of the first major institutional investors to enter the Indian logistics market with LOGOS in 2017, and has recently formed a joint venture with Prologis to build a platform in Brazil.
Rita-Rose Gagné, president for growth markets, says that the LP intends to double its investments in the sector in Asia-Pacific and South America in the coming years. “The modern industrial stock in Brazil is very small compared to the population, and it is one of the largest consumer markets in the world. The gross leasable area per household in Chicago is 14 times that in São Paulo, which has a larger population. Notwithstanding the negative political and economic noise at the global level, you want to find a way to tap into rising consumption, and retail and logistics are how you do that.”
South-East Asia is also a popular regional market for logistics investors. China’s vast population and enthusiastic embrace of e-commerce are an enormous draw. Meanwhile, the huge capital values achievable for multi-story warehouses in Japan’s supply-constrained cities allow equity-rich investors to write big tickets.
“The Asia market has been going pretty mental for the last 12 months. Logistics is still the most sought-after girl at the dance,” says Stuart Gibson, co-chief executive at Asian logistics specialist ESR. “We have new enquiries from pension funds and sovereign wealth funds. The demand for investments is not being met.”
The only clouds on the regional horizon are the Chinese economy’s faltering – albeit still comparatively strong – growth and the potential damage that could be wrought by a trade conflict with the US. “It looks like China might have hit a bump in the road, which makes me a bit more nervous about how aggressive I should be this year buying land in China, Korea and Japan when I think there is potential for a slowdown in consumption and growth,” muses Gibson.
Much of the capital raised for industrial strategies is still focused on established western markets, however, in particular the US, which accounted for almost half of sector-specific fundraising in 2018. It is the most developed logistics market in the world, with more modern facilities in which to invest than any other, but even there, capital demand far outstrips the available assets.
“Most US institutional investors are now realizing we are under-weighted to an asset class that has good cashflows and offers better capital efficiencies than offices,” says Anthony Breault, senior real estate investment officer at Oregon State Treasury. “However, their weighting and exposure has been determined by whatever the investor was capable of getting. Not many asset managers in the sector have national footprints, so it is difficult to establish a scalable relationship and build a portfolio. There will be a few large portfolio transactions, but for most it will be a long, slow process of competitive aggregation.”
Europe is also considered a mature market, but the region could yet see significant growth, suggests CBRE Global Investors’ EMEA head of logistics, Philip Dunne: “The US still has between three and four times the modern stock compared to Europe, yet the European population and economy is larger overall, so we still have further to go in terms of the creation of product. When you compare the property cycles, Europe has probably already caught up in terms of value, but we are behind by a couple of years in terms of rental growth.”
Could the flood of capital seeking a home lead to too much risky speculative building? Jack Cox, head of EMEA industrial capital markets at brokers CBRE, thinks not: “Even where we have seen completions rise, take up has exceeded completions by a substantial margin in every year since 2009, so vacancy rates have continued to compress and are now on average around 3.5 percent. With vacancy that low speculative development is naturally de-risked, so institutional investors are able to pursue development yields as opposed to investment yields, and lock that in on a very well risk-adjusted basis.”
Ballon warns against complacency, however: “In 2019, there will be continued strong demand but also a continued supply of capital and that is something we pay close attention to. Investors sometimes just follow trends; if you are an investor without a lot of industrial exposure that could lead you to want to invest in the asset class. That is not how one should invest because it carries the danger of not assessing the risk properly and not getting the expected returns.”
Investors can see plenty of attractive opportunities in logistics over the coming year. However, many also believe that the real estate cycle is at a late stage, and will think twice about taking on too much risk, even – or perhaps especially – in the market’s hottest sector.