The European logistics market is red hot at the moment. This might come as no surprise to investors, but should it be a concern?
First, the sensible rationale for investing in logistics real estate. In an era when bond yields are low and quantitative easing has left investors wary of core fixed income, there is greater demand for alternative assets.
Property has obvious attractions, but Covid-19 has wreaked havoc in the world of commercial real estate. There are doubts about the security of rental income from retail – a sector that is now oversupplied in many parts of Europe. The economics of this sector have fundamentally shifted due to the point of sale moving from in store to online, resulting in current rental levels being no longer affordable in many cases.
An impact on office and residential
And we are yet to see how homeworking may impact on office space. Since March offices in Paris, Madrid, Milan and across Europe have often been ghostly empty.
If office workers all choose to work from home just one day a week after lockdown lifts, it could reduce the demand for office space by as much as 20%. That is an unlikely, worst-case scenario – none of us likes hotdesking, and companies often have long leases. However, there is plenty of anecdotal evidence of small companies closing their offices altogether, large companies downsizing and people moving out of expensive cities, working from home in areas where residential prices are cheaper and living standards higher.
This latter trend may have an impact on the residential sector, too, which may see some rebalancing in some countries. Meanwhile, in Germany, where residential property is a significant asset class, state governments are debating rent controls. In Berlin, for example, landlords are being forced to reduce rents.
Pandemic has benefited logistics
Logistics, in comparison, has benefited from the impacts of the pandemic. Covid-19 has conflated 10 years of evolution in ecommerce into just one year. Research by PwC shows that 70% or more of French and Italian consumers bought more groceries online last year and most expect to continue doing so. Most European countries have seen at least a 25% increase in online shopping generally.
Inevitably, this has fed through to demand for logistics buildings that are vital to ecommerce. Research by CBRE shows a pick-up in demand in continental Europe. Belgium, Italy and Poland all set new records in leasing activity.
Perhaps because of constraints on new construction, completions of new logistics buildings were down 11% from 2019. In constrained markets that led to an increase in rental growth – Belgium was up 5.8% year-on-year on average, Italy up 1.8% and Germany up 1.4%. Other regions saw no change.
Investment volumes were up 11%, and Belgium, Italy, the Netherlands and Central Eastern Europe all saw record levels of transactions.
A sign of rising prices is that prime yields compressed 20-50 basis points across European logistics markets. Though not as attractive as they were, relatively speaking, yields still look attractive – Belgium (-50bps to 4.25%), Netherlands (-40bps to 3.6%) and Spain (-35bps to 4.75%) are the three countries that saw the sharpest yield compression. Bear in mind that European government bond yields are firmly in negative territory.
This is far from bubble territory, but there are warning signals. Vacancy rates ticked up marginally in certain regions – though they remain below 5% generally.
There are two important lessons to draw from this data.
1. Buy selectively
Investors have to be selective. We are seeing what we call “carpet bombers” – investors who have taken the money that has flown in and are buying indiscriminately. They are buying properties we would not touch – older properties, not configured to be re-let (we like properties that appeal to a wide range of tenants) and not green enough in a world where sustainability and energy efficiency is becoming more important.
They are buying in the wrong places. The most successful logistics properties are close to urban centres and with good transport links. Places like Bornem, near Antwerp – Belgium’s most populous city – have zero vacancies on logistics properties. Where there is demand rents will grow. We are currently building a 15,000-square-metre logistics unit there and have been surprised by the number and quality of tenants already interested.
Though Europe is vast, the options in good locations like this are actually relatively sparse. You need a good network of contacts to unearth opportunities early. We have had to work hard on that over the past few years and now have good relationships with developers in our key markets.
To take full advantage of the pipeline this has created, we recently announced plans to issue €200m (£171m) of equity. We are also looking at intelligent ways to manage our capital and use debt smartly, recognising that diversification reduces risk.
2. Add value
In a market like this, where yields are compressing, you need to really add value – or to quote that unpleasant phrase popular with property managers: “Sweat the asset.”
It is not too difficult to find plain-vanilla buildings on long leases to businesses like Amazon, but the yields are now modest – and this year we expect them to compress further.
New developments in the right location can generate a 7% yield on cost and a subsequent uplift in capital valuations, which beats sitting on assets that have matured. This is why we recently sold a property in Lodz, Poland, for €65.5m having acquired it in 2019 for €55m.
We have six near-term investment opportunities in the pipeline – four in Germany, two in Italy – which are all off-market, brought to us through our partners. One is a brownfield site in the North Rhine-Westphalia – a super-prime German logistics centre. This will be a 22,000-square-metre property, and I would expect it to be leased before it is even completed.
By aggressively recycling capital like this, reinvesting in areas where vacancy levels are low and where value can be added, good managers are able to counter any further downward pressure on logistics yields, mitigate risks and ensure that this asset class continues to contribute positively to investor portfolios.
Nick Preston is the fund manager of Tritax Eurobox plc
