Investing in Logistics
The February issue of PERE magazine featured our special supplement, Investing in Logistics. For more on the sector, see our stories below:
Logistics was the real estate asset class that was always a bridesmaid and never a bride. Then, around five years ago, it took off its glasses, shook out its hair and dazzled the institutional investment world so thoroughly that suitors have fallen at its feet ever since.
Between 2012 and 2017, some $54.7 billion of capital was raised around the world for logistics funds, including almost $21 billion in Asia-Pacific alone, according to PERE data. In that period, 10 funds have closed at more than $1 billion and the biggest fundraiser, Global Logistic Properties, alone garnered more than $15 billion of capital.
Since the global financial crisis, logistics has eclipsed office and retail as the most popular of the three main commercial asset classes for many of the biggest private equity investors. Among them is real estate investment manager CBRE Global Investors. “Going back a few years, we made logistics our top pick in terms of sectors globally,” says EMEA chief executive Jeremy Plummer. “In our global fund, it is the number one theme we are heavily allocated to, and that is replicated in all of our portfolios around the world.”
Most institutional investors now have an allocation to the sector, says Martina Malone, global head of capital raising at logistics real estate specialist Prologis. “My phone doesn’t stop ringing, and that definitely wasn’t the case eight or nine years ago when the sector was a lot less institutionalized. In terms of the fundraising environment, in 2017 we had an amazing year.”
The cause of the sector’s precipitate rise can be summed up in one word: demand. That encompasses both heady investor demand for an asset class combining good risk-adjusted returns with a structural story that inspires a high degree of confidence in its resilience; and occupier demand for an undersupplied property type that in a short time has become crucial to the success of many businesses.
“There is a lot of demand for industrial real estate that is demonstrably coming from the digitalization of the world and the e-commerce drive. This is forcing businesses that want to service their consumers more rapidly and efficiently into looking at their supply chain and warehouse footprint and driving them into markets close to consumers where occupancy is very high, vacancy is very low, and there is positive rental growth,” observes Greg Goodman, chief executive of global industrial property group Goodman.
“Investors see industrial as the retail of the future because that is where a lot of retailing is going on now, with goods distributed straight from the warehouse to the customer. They are looking at it as an asset class that is servicing a fast-growing retail consumer who wants greater speed of delivery.”
Technological change, in particular the rise of e-commerce, lies at the heart of the sector’s appeal. Research by eMarketer estimates that e-commerce sales worldwide will rise by 23.2 percent in 2017 to $2.29 trillion and account, for the first time, for one-10th of total retail sales.
“Every sector, basically the whole investable universe, is strong at the moment, but logistics real estate is special because it has genuine underlying structural growth with a plausible technology story behind it,” argues Logan Smith, head of logistics at advisor BNP Paribas Real Estate. “Pick a stock at random from the S&P 500 and I guarantee you their board is struggling with what is going to happen because of the impact of technology. In logistics real estate, we feel pretty good about the long-term impact of technology, so the reasons for the sector’s popularity are as structural as you can get.”
In the US and Europe, online retailing is catching on quickly with consumers, but, in Asia, it is the scope for expansion that makes for a particularly compelling story, suggests Stuart Gibson chief executive at e-Shang Redwood, one of the region’s largest developers. “In terms of overall sales, in the UK e-commerce is 12 percent and the US is 10 percent. Japan is only 6 percent. It is quite far behind the rest of the world. The triangle between Seoul, Shanghai and Tokyo accounts for 60 percent of Asian GDP and 25 percent of global GDP. Countries in this triangle are beginning to really grasp the new economy. The volumes are just starting to blossom,” he says.
Warehouse investments are filling some of the allocation in investors’ portfolios that would have been dedicated to retail, an asset class experiencing the negative effects of the same e-commerce trend.
“We saw logistics as the structural winner versus retail with the retail footprint shrinking and the warehouse footprint growing,” says Plummer.
Meanwhile, alongside the growth of e-commerce, bricks-and-mortar retailers have needed to reorganize their own supply chains, or become multi-channel operations to stay competitive, further boosting tenant demand for modern logistics space.
Logistics is also closing the yield gap with the office sector, says Jack Cox, head of EMEA industrial and logistics capital markets at CBRE: “If we look in our data set as far back as the early 1990s the spread between prime logistics and prime offices was approximately 350 basis points and over time it has narrowed to around 200 basis points. That is symptomatic of the re-rating of logistics as a sector and the increased weighting of capital towards it. It used to be 6-8 percent of a balanced real estate portfolio. Today, that is much more like 12-20 percent and even higher in the case of some investors.”
Furthermore, logistics offers investors an attractive credit play, argues Cox: “Some like the yield spread that is available between the corporate bond of a logistics occupier, and a real estate investment, which is backed by a physical asset, with the benefit of inflation hedging through the consumer price index linkages in the lease.”
Moreover, he adds that research by consultant Mercer shows that of all the assets classes, logistics has the weakest correlation with, and is the best diversifier from, equities, bonds and cash – particularly on a short-term basis.
In spite of the narrowing of the cap rate spread, Ben Bannatyne, president of Europe at Prologis, says the asset class retains the advantage of being relatively high yielding compared to offices and retail. “There are pretty stable returns with a lot less capex than if you were investing in, for example, a large shopping center or a grade A office block. And tenant retention is very high. Our retention rate for 2017 was over 80 percent, so it is a stable high-yielding product and e-commerce has been the icing on the cake for many investors because a huge amount of new occupier demand has been created.”
E-commerce driven demand tends to be focused around the big cities, where land is expensive and scarce. Meanwhile, unlike the period which led up to the global financial crisis, funding for speculative development is difficult to secure for all but a handful of big logistics developers with strong balance sheets, which has led to a relatively low level of new supply. Vacancy is very low. Bannatyne estimates the occupancy rate of the main logistics platforms in Europe and the US at around 95 percent.
Consequently, logistics investors have been able to take advantage of rental growth. Rents in the US have been increasing for two years, says Bannatyne, and that growth shows little sign of abating, while more of the same is expected in Europe: “We have not seen real rental growth in Europe for as long as I can remember. It started in the UK two years ago and we have had double digit rental growth there for the last two years and it is starting to come to continental Europe in some of the tighter markets. I think in 2018, people will start pushing rents to levels that we haven’t seen before. If the US and UK are anything to go by then continental Europe is going to see a real treat from a landlord’s perspective over the course of the next 12 to 24 months.”
While the occupational and investment demand drivers are incontrovertible, to a degree logistics’ increased popularity is a result of an improved understanding of the asset class that affords investors greater comfort despite its rapidly-changing landscape, argues Cox: “The most striking and overlooked change we have seen is that institutional investors in the market define their view of real estate risk not as the institutional specification they are looking for, but how well their capital is aligned with the supply chain of their tenants.”
“Investors see industrial as the retail of the future because that is where a lot of retailing is going on now, with goods distributed straight from the warehouse to the customer”
Asset types of which investors were once suspicious, like small, low-site coverage cross-dock units for home delivery and multi-level fulfilment centers packed with robotics are now acceptable to mainstream core investors, he says.
The real estate sector, and the investment environment generally, has had a protracted bull run, but the length of the current cycle has led to concern that a correction could be imminent.
Steve Schutte, chief operating officer at GLP, believes in that context logistics holds particular appeal for investors. “To my mind we are not on the upswing of the business cycle and people are very cognizant of that. In terms of the rise and fall of cycles, logistics is a fairly transparent asset class. In logistics, you are watching domestic consumption so there is a little more visibility into the future. It is also something you can turn on and off relatively quickly. We have very short development cycles so it is easier to pull back when you see softening,” he argues.
However, there is confidence among logistics real estate professionals that, barring a severe slowdown, growth will continue at its current pace. “The continued structural tailwinds, as a result of e-commerce, will extend the cycle,” predicts Nick Cook, chief executive of European logistics platform Gazeley, which was acquired by GLP at the end of 2017. “The supply-demand dynamics in all of our core markets are probably in a better place now than they have ever been before. We think the good times are here for a considerable number of years.”
Investors are plighting their troth to logistics in increasing numbers because they believe it has fundamental attributes that will not wither over time, an attitude that looks set to provide the basis for a long and happy relationship between institutional capital and its new darling.