Alpha REIT: Kempen Real Estate Update: Logistics real estate is red hot
Logistics rental and investment markets are thriving on the back of strong growth in online retail sales and changing supply chains. We see that consumer expectations are changing quickly and same day delivery is becoming the norm in all developed markets. Rents of logistics facilities are typically a fraction of the total costs of a good bought by the consumer whereas logistics can typically save most time and costs in the supply chain. To be able to do business in this rapidly changing environment, online retailers need larger regional distribution centres with high technological requirements as well as last mile delivery locations or urban warehousing. In our opinion this creates a massive opportunity for real estate investors.
Our team has been identifying and exploiting the logistic trends for a number of years. However we believe the investment markets have reached a stage where pricing becomes high and little discrimination is made in terms of asset and location quality. With same day delivery becoming the norm, asset location becomes more important than asset quality (logistics was probably one of the last sectors where this wasn’t the case until recently). In the proprietary location analysis, our team clearly distinguishes between regional distribution centres versus urban warehousing. The latter category has tremendous upside as last mile delivery locations are scarce, typically located in densely populated areas, compete with other use (such as residential and offices) and building permits are more difficult to obtain,. For urban warehouses with high expected rental growth, investors would require a lower initial yield to meet their return requirement.
Since 2011 Kempen has been building a unique proprietary database on property quality that enables us to score location quality and gauge the underlying prospects for future rental growth and capital expenditure. Our database shows that urban warehousing locations are typically characterized by high population density within the catchment area, higher incomes and high density of interstate highways. Property specialists would be quick to identify that our analysis does not differ that much from analysing shopping centre catchment areas. For urban warehouses there is much more upside to current rents and values given the uniqueness of some locations, unless driverless trucks come into play soon.
Regional distribution centers have very different dynamics and drivers for future returns compared to urban warehousing. These assets are typically larger boxes (100.000 square meters) in out-of-town locations (20-30 kilometers outside urban areas), well connected to highways, rail, airports and harbors. We use a geospatial analysis combined with, amongst others, cargo volumes to determine future returns. We expect more muted rental growth for regional distribution centers and therefore would require a higher initial yield to meet return requirements.
“Urban warehouses are the assets that make the headlines.”
Urban warehouses are the assets that make the headlines, experience outsized rental growth and trade at very low initial yields. However, the urban warehouse segment of the market is only approximately 10% of the total logistics assets. The remaining 90% is either regional distribution centres or all the assets in between. These assets will generate much lower rental growth. Many investors do not discriminate sufficiently between the two and simply extrapolate rental growth expectations on all that is remotely related to logistics.
A good example of this is a recent transaction of two larger distribution centres in Barcelona, leased to a fashion retailer. These caught our eye as both were transacted at <5% net initial yields, which at first sight seemed to us extremely low for distribution centres.
With 18-20 years remaining until the first tenant break in the lease, we calculate that close to 1% discount rate and 2% annual rental growth need to be applied in order to justify the pricing, assuming the terminal value after 20 years is 0. The terminal value is the key parameter in this analysis. Whilst our assessment might seem a little too bearish, we highlight that locations 20-30 kilometers outside Barcelona are far less unique than last mile delivery locations.
Our location analysis shows that seaport and air cargo volumes are much lower for Barcelona than many other European cities. In addition, shipping from Barcelona or Marseille to Africa might make sense for this specific retailer, who sells in Africa, but probably much less so for other retailers. Neither of the assets is well connected to major rail networks. This, combined with very tenant-specific designs for both assets, means that the risk of obsolescence is real and the value of the building and location post lease expiry should be low.
Last but not least, our required return for Spain is higher than, for example, for Germany, as government bond yields are hovering c100bps higher and the country has always been much more relaxed when it comes to planning policies than other European countries. Whilst a 20-year lease might feel safe today and in the coming years with an international fashion retailer as tenant,. it doesn’t justify whatever price. Overpaying for a location has historically been the number one reason for asset write-downs and one of the most important drivers for real estate value destruction.
We agree that logistics real estate is hot. However, investors have to be very critical. Our analysis shows that location quality is extremely important for driving future returns within logistics. We see plenty of reasons to be worried with today’s pricing for regional distribution centres on long leases. We continue to see further upside for urban warehouses and last mile delivery centres in good locations.
The views expressed in this document may be subject to change at any given time, without prior notice. Kempen Capital Management N.V. (KCM) has no obligation to update the contents of this document. As asset manager KCM may have investments, generally for the benefit of third parties, in financial instruments mentioned in this document and it may at any time decide to execute buy or sell transactions in these financial instruments.
The information in this document is solely for your information. This article does not contain investment advice, no investment recommendation, no research, or an invitation to buy or sell any financial instruments, and should not be interpreted as such. This document is based on information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such.
The views expressed herein are our current views as of the date appearing on this document. This document has been produced independently of the company and the views contained herein are entirely those of KCM.
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