This article is sponsored by Logistics Capital Partners.
In November, global investment manager Invesco Real Estate demonstrated its confidence in specialist logistics platform Logistics Capital Partners, by increasing its preferred equity investment in the business by a third. The additional capital injection will allow LCP to exceed its three- to five-year strategic plan to develop over €1 billion of new distribution space across Europe. LCP co-founders James Markby and Kristof Verstraeten, and Tom Emson, senior director of transactions at Invesco, discuss how investors can access the market for the large and complex modern facilities increasingly being demanded by European logistics occupiers.
Why is backing a platform like LCP a good strategy for Invesco?
Tom Emson: We have high conviction on this space and we want to be overweight in it. We invest in logistics across a number of strategies globally and within Europe, ranging from core to higher-returning strategies like our initiative with LCP. By maintaining close relationships with specialist logistics development platforms, we can access product at an early stage of its development, and we see a competitive advantage in being able to invest in high-quality, modern, highly automated stock.
James Markby: The increase is a combination of short-term funding for live projects and capital that will allow us to secure land and do the early-stage work on new sites. Because it is effectively an investment into LCP as a company, it is very helpful in increasing our performance in terms of speed and reliability of execution. We can be very nimble and efficient in jumping on the opportunities because we know the capital is there. That ability to be entrepreneurial is exactly what you need in this highly competitive market context with a lot of money chasing logistics.
Kristof Verstraeten: Meanwhile, the trend in the market is for super-large, super-complicated developments. We are now active in the Netherlands, Belgium, France, Spain and Italy, and doing a lot of repeat business for customers like Amazon, and while we are probably doing a number of projects that are in line with our business plan, they have turned out even bigger than we expected, with a variety of advanced technological and environmental features that make them very capital-intensive to develop.
Are environmental issues gaining traction in the logistics sector?
TE: We assess ESG factors for all of the investments we make across all sectors. It is front of mind and has been for a while now. We target the higher sustainability levels of labels like BREEAM or a LEED in the products we are investing into while managing our existing portfolios to try to improve ESG aspects.
KV: A building that is more energy efficient is going to be cheaper to operate, even though it may cost a little bit more at the outset. Secondly, environmental performance and climate change is a huge topic and it will not become any less important in the coming years. Real estate is a long-term asset and in order to be ready for the future all the logical arguments point toward making sure that buildings are sustainable and energy efficient. We see most of the speculative developers going down this route, but you can go much further working together with a tenant because a very environmentally friendly building will be more expensive and therefore will need a higher rent that will be offset by cheaper operating costs. On build-to-suit projects, large corporate occupiers are pulling the real estate market along with them on sustainability. It can be a slightly more complicated business case to make when you are building speculatively because your expectations of increased rent are an assumption that still needs to be tested and validated, so while speculative development is becoming increasingly sustainable it is happening in more incremental steps.
JM: There is also a change in some of the aspirations of third-party logistics providers in this area, with the types of supply chain planning and longer-term business plans they are proposing to their end customers. In the past, their occupational strategies have typically been relatively short term and reactive because of the length of logistics contracts, but we are seeing a trend of tendering with proposals for longer-term supply chain strategies, adopting 15-year plans that allow them to consider completely new designs and operationally more efficient buildings, which ultimately provide a lower operating cost in the longer term. Working in tandem with some of these 3PL groups is creating some interesting new project ideas and wins. These are all complimentary push/pull factors for longer-term occupational planning, all coinciding to create a more compelling case to review the whole long-term efficiency of the whole supply chain operation.
How do you strike the right balance between speculative and build-to-suit development?
KV: Our development business is only 25-30 percent speculative. In some ways, build-to-suit is more efficient because you can turn your capital around faster and therefore it often gives you higher IRRs. However, the two approaches are complimentary to a large degree because they are both fed by the acquisition of developable land. To ensure a pipeline of sites, you need a team of specialists and engineers looking for land and taking it through the various stages of master-planning. When you have been through that process it might coincide with a build-to-suit need from a tenant, but you might also find it is a good piece of land to start speculative development.
JM: You need to analyze the specifics of your site and where it sits in relation to the competition. Where there is already a supply of smaller units it would be unwise to dilute the appeal of a site that could accommodate a large pre-let by breaking it up for speculative development. Generally speaking, across Europe it is becoming harder to source deliverable large-scale sites, in locations that work for end users, so if through master-planning we can create one of those rare opportunities, that is where we prefer to spend our time. The preparation of those sites is a manageable and controllable technical process that enables value creation that is not predicated on capital markets, economic cycles or the operating environment.
TE: On a risk-adjusted basis, there has been far more appealing value in build-to-suit schemes. That said, we do very granular research in a number of markets across Europe and we are fairly comfortable where most of them sit from a demand and supply perspective, so leaning into some speculative development over the last 12 to 24 months has been shown to be a well-priced risk. Moreover, one of the attractions of the logistics market is that you are exposing yourself to development and leasing risk over a shorter period because warehouses can be built comparatively swiftly compared with other asset classes.
What challenges do investors in European logistics markets face?
TE: The standard warehouse boxes of five to 10 years ago have been superseded by buildings that are far more sophisticated in their design and specification. That increases delivery costs and means that capital values to build this sort of real estate and the rental levels that occupiers are paying for it have moved on significantly. For investors, it is important to understand to what degree that is caused by inflation in capital values and pricing at this point in the market cycle, and how much is a structural shift because of a change in the nature of the product.
Meanwhile, there is a bifurcation of the demand between smaller last-mile product and large-scale, automated build-to-suit sites. Somewhere in the middle, there is a lot of traditional general warehousing, and it is important to be invested in the right part of the market from both a geographic and a product-type perspective. The other risk we look at closely is something very prevalent in the retail sector – covenant risk. If one is buying long-leased e-commerce-related logistics it is important to bear in mind the covenant strength of the operator and the nature of their underlying business. There are several retailers where you wouldn’t rush to buy one of their stores, so you have to be cautious about buying one of their logistics operations.
What are the prospects for the market in the year ahead?
KV: When we have had a good run in the occupier and capital markets for a relatively long period, the logical thing is to be vigilant for signs of it slowing down. Actually, in the last three months of 2019 the evidence has mostly shown the opposite: no slowdown, more projects, more demand, more tenders. We are a bit stronger in the southern European markets of France, Spain and Italy where there is definitely a lot of work still to be done to reconfigure supply chains, while the German industrial sector is slowing down a little bit, so it might become slightly quieter in some northern European markets. In addition to the strong occupier demand, there is still plenty of capital appetite when we exit our projects, and that capital is slowly getting more comfortable with larger and more modern logistics buildings because investors see them as the projects of the future.
Case study: Kering Group global logistics hub, Trecate, Italy
Luxury that doesn’t cost the Earth
Kering may not be a household name, but the global luxury group’s brands, which include Gucci, Saint Laurent and Alexander McQueen, certainly are, while the company’s decision to take a 15-year lease on a 1.7 million square foot distribution hub in northern Italy was unquestionably a big deal, marking as it did one of the largest logistics pre-lettings of 2019. At well over €150 million two-building campus, developed by LCP and backed by Invesco funding, is due to be completed in the first quarter of this year.
The project epitomizes the trend for occupiers to consolidate their supply chains into larger, more technically complex, greener hubs, says Verstraeten. “It got bigger and more important as the customer decided to integrate more of their business and brands into that building, taking the consolidation and automation trends as far as they can realistically be achieved. The automation and systems within the building are of a cost that is of the same order of magnitude as the building itself.”
He adds that Kering was also determined to push the envelope on sustainability: “The buildings will be the first LEED platinum – the highest rating – certified logistics buildings in Italy, and possibly Europe,” he claims. “This is achieved by using the best and most advanced specifications for all parts of the buildings and their electrical and mechanical systems. Once completed, the buildings will be heated and cooled via heat-pumps using geothermal wells. Furthermore, the entire surface of the roof will be used for solar panels, allowing Kering to also supply stores and other sites with electricity generated in Trecate.”