Post-covid, is the logistics sector the new office?

The oft-quoted phrase “logistics is the new retail” has come true. Industrial investment volumes in logistics overtook retail’s for the first time in 2019, attracting $196 billion globally, which represents a sixfold increase since 2009, according to Savills. In a challenging 2020, logistics held its position as the third most-invested asset class after office and residential – and second within the commercial real estate space – accounting for a record 20 percent of all global property investment in the first half of last year.

The sector is benefiting from the current global e-commerce boom, which has accelerated during the pandemic. Meanwhile, the work-from-home shift during the covid-19 crisis is prompting more questions about the future of offices, an asset class that has traditionally formed the basis of most institutional real estate portfolios.

Given these dynamics, will logistics step up to become the prime core asset of the future, even ahead of offices?

“All the lead indicators in logistics point to stable and sustainable income streams,” says Marcus de Minckwitz, director, regional investment advisory, EMEA at Savills. “Given increased demand and supply struggling to keep up, you should also see rental growth. If you just compare offices and logistics for what they’re offering in terms of income, then logistics is looking more attractive at the moment, which is why we’re seeing so much interest from investors.

“Logistics is rising to the top as the most desirable, the most secure, the most stable income product, but the caveat is its market size compared to offices. If logistics typically is 10-20 percent of investors’ portfolios, offices are the mainstay, with 40-50 percent in the portfolio’s share. It is very difficult for logistics to step into being that mainstay of the institutions as it simply isn’t that size of asset class.”

“A lot of investors look at logistics today not simply for rental income, but as a total return investment”

Christian Jamison
Valor Real Estate

Market participants canvased by PERE agree logistics will not overtake offices in investors’ portfolios as they cannot access the sector in scale. However, even though office has the largest share of global property investment, Savills’ data show it gradually declined from 47 percent in 2007 to 34 percent in H1 2020. This declining trend could reflect “investors looking for long-term, secure income streams elsewhere and signs of becoming more sector-agnostic,” notes Mike Barnes, associate, European research at Savills.

Stability and resilience

As logistics benefits from a continuing increase in online retail sales, with the pandemic accelerating the shift away from physical stores, the sector is well-placed to provide stable income over the longer term, particularly for assets in good locations within a short distance of consumers, industry sources point out.

Relative to other real estate sectors, most notably retail, logistics has historically brought higher returns. According to the INREV Quarterly Index – which measures the performance of European non-listed real estate funds investing 90 percent or more across Europe – logistics has a five-year annualized total return of 12 percent, which compares with a total return of 6.83 percent for office and 1.19 percent for retail. Breaking down logistics’ five-year annualized total return shows 5.6 percent coming from distributed income return, and 6.1 percent from capital growth, which suggests a balance between rental income and capital appreciation.

“Unlike a decade ago, a lot of investors look at logistics today not simply for rental income, but as a total return investment,” argues Christian Jamison, managing partner at Valor Real Estate. “They recognize the potential for capital growth. In the urban logistics space, in particular, you’ve got possible alternative use upside, whether it’s through conversions or intensification of sites. Alongside rental growth, that development opportunity adds a further element of capital appreciation to the strategy.”

Amid the covid-19 crisis, logistics has also shown resilience. The INREV Quarterly Index recorded a total return of 3.4 percent in Q3 2020 for the sector. This compares with total returns of 0.79 percent and -1.4 percent for office and retail, respectively.

Meanwhile, take-up is reaching record levels in key logistics markets. The UK, for instance, saw its best H1 last year, with take-up 38 percent above 2019 levels, Savills’ data show. More broadly, across Europe and the US, the average vacancy rate stands below 5 percent.

“While at the moment there’s a huge uncertainty about the future use of offices, you don’t see this in the logistics sector,” says Martin Czaja, spokesman of the executive board of BEOS, a German logistics developer and manager, and part of Swiss Life Asset Managers.

“I believe for many institutional investors it’s safer to go into logistics. Considering fast-growing e-commerce, the logistics sector offers great investment potential because of the growing demand and the high values.”

Growing appeal

The wall of capital seeking to be invested in these opportunities seems to get bigger by the day. BEOS’s Czaja recalls a forward logistics deal in Berlin back in 2020 that attracted 30 bidders in its first phase of development, when the asset was not even fully let. “The investment was of more than €100 million and, with 30 potential buyers for that one opportunity, there was €3 billion in capital looking for logistics exposure,” he says.

Institutional investors turning to logistics have been driving increased capital flows. Recent examples include the joint venture formed in December 2020 between Stockbridge Capital and the National Pension Service of Korea, through which the partners committed to acquire a 14.3 million-square-foot portfolio of core logistics properties in the US valued at $2 billion.

Last September, the Canada Pension Plan Investment Board announced a $235 million investment in a $2.6 billion Japanese logistics fund launched by GLP a month earlier. Meanwhile, more institutional players are making their first forays into the sector. Advised by M7 Real Estate, Croatia’s largest pension fund, AZ, made a
€21 million debut logistics investment in October 2019 as part of its push to diversify into real estate.

“Over time, institutional investors have become more sophisticated,” says Logan Smith, head of logistics for Europe at investment manager and developer Hines. “Five years ago, institutional investors would ask relatively basic questions about buildings such as what’s the dock-door ratio, the clear height and the floor-loading capacity. Now, investors have begun to develop a deeper and more nuanced understanding of other important aspects, including the supply-chain dynamics of the underlying tenant, proximity to labor or electricity, and so on.”

“For the foreseeable future, the return profile of the logistics sector looks better than for offices”

11Alistair Calvert
Clarion Partners Europe

As investors continue to pour more capital into logistics, yields have compressed relative to historical norms. Between 2007 and 2017, global industrial yields averaged 7.5 percent, 70 basis points above office yields, on average. By the second quarter of 2020, industrial yields had moved to 6.1 percent, just 10 basis points above office yields, according to Savills’ data.

Despite compressing yields, now close to office yield levels, Alistair Calvert, chief executive of Clarion Partners’ European investment arm, which focuses on logistics and industrial properties, notes the benefits of the basic maintenance that warehouses naturally require: “Logistics is much less capital-intensive in terms of refurbishments than office tends to be, so even if it had the same yield as office, you would be able to distribute more cash.”

Overweight industrial

Although offices typically make up the largest portion of investors’ portfolios, some players, such as Clarion Partners, prefer to give more weight to logistics. The US-based property manager has been overweight in logistics for seven years now.

As of Q3 2020, it had $55.6 billion of assets under management – $22.4 billion in logistics and $10.2 billion in office assets. The company has been very intentional about its focus on logistics, Clarion’s Calvert says, as the sector has outperformed for a long time. “For the foreseeable future, the return profile of the logistics sector looks better than for offices,” he adds.

Tim Wang, head of investment research at Clarion Partners, anticipates less interest in office over time across the industry: “Investors liked office in the past because it was efficient to deploy a lot of capital quickly and a shining office building looked good on the cover of the annual report. However, over time investors realized that office buildings tend to require significant ongoing capex, and demand for office space is often more volatile through economic cycles, resulting in long-term underperformance.

“As such, portfolio allocation weighting in the office sector has declined steadily over the past several years and this trend will likely continue over the next few years.”

If he is right, logistics is likely to benefit from this shift. Given its supply-demand imbalance, the sector is well-placed to provide rental growth and strong returns for investors. And, although its size is still dwarfed by the office sector, logistics is set to continue on its growth trajectory, remaining firmly at the heart of core investment strategies.