IPD data shows logistics consistently outperforming. So is it poised for renewed investor interest in Europe, ask Eleanor Gilry and Doug Rowlands
In October, Investment Property Databank (IPD) launched its Pan-European Logistics Performance report to European real estate leaders to discuss the emergence of logistics as an asset class in its own right. IPD, with a consultative group of the world’s leading logistics investors and partners BNP Paribas Real Estate, CBRE and Jones Lang LaSalle, set about to determine a definition for logistics assets that has been drawn from IPD’s standard industrials segment. The aim of the report was to increase transparency and clarity to the industrial and logistics sector.
Determining the definition for logistics was a difficult challenge for IPD; retail, offices, residential, hotel and industrial, for example, are commonly accepted as standalone property types. However, real estate brokers and other firms define further sub-sectors, such as retail formats or office grades, in different ways.
Brokers have tended to split the industrial property sector into at least three groups: warehouse/distribution, light industrial, and manufacturing. Even though the definitions of these industrial sub-sectors are not standardised across the industry, it is the names that convey the distinct activities of the occupiers.
Over the past 20 years the logistics industry has changed, including the growth of international sourcing and the centralisation of inventory, which has led to further demand from retailers, manufacturers, and logistics companies for large distribution centres with good internal and external layouts to optimise storage and throughput. This change began in North America, spread to Japan before catching on rapidly in Europe and elsewhere. Age, size and obsolescence are among the primary factors separating modern logistics from older distribution centres, even though performances of the overall industrial sector is measured as a single coherent group.
Therefore, the function, age, and scale of an industrial property have become IPD’s defining criteria for the definition of logistics. Because the construction of modern distribution facilities capable of meeting today’s logistics activities appeared relatively recently, IPD defined the age parameter of logistics as those warehouses completed from 1998. Facilities exceeding 10,000sqm were deemed to be large enough in scale to meet the modern logistics standard.
Another challenge for IPD was analysing logistics performance, in particular whether this sub-sector has matured enough for logistics property performance to be adequately measured across Europe over the long term. By using 1998 as the strict cut-off point for construction, there were relatively few assets to measure in the early years.
Prior to 2005, IPD identified fewer than 300 logistics assets in 11 European countries. By 2008, however, the base has grown significantly to include at least 700 assets across 17 countries. The value of all logistics assets exceeded €12bn by 2011, or about 24% of the value of the pan-European asset base; its maturity varies widely across European markets.
As of 2011, IPD pan-European logistics produced total returns of 6.4% year-on-year in local currency. Logistics performance in Europe reflected a mix of maturity and economic conditions. Total returns in parts of northern Europe (Sweden, Czech Republic, Germany, and Belgium) exceeded the pan-European average by 250-450bps. Despite a sluggish economy, UK logistics outpaced pan-European logistics for total returns in 2011, albeit by a narrower margin. In Europe’s struggling peripheral markets such as Portugal, Spain and Italy, logistics returns fell well below the pan-European average in 2011. With the exception of Portugal, income return in most markets held up well.
The pan-European indices for property-specific total returns converged more in 2011 than in any of the past 10 years, with all sectors falling in a tight band between a high of 7.2% (retail) and a low of 6.2% (office). The logistics sub-sector produced total returns somewhere in the middle at 6.4% in 2011, narrowly under-performing the IPD Pan-European Annual Property index, which was 6.6% for the year.
This slight under-performance is a bit of a surprise, given the relatively high-income return levels for logistics. Rapidly rising yields – due more too weak investment levels than to rental decline – are a likely explanation for the slight under-performance. One important concept clearly was left out of the analysis: the confirmation of long-held expectations about income return in the logistics sector. In fact, the lowest year for income return equalled or exceeded the highest years for retail, office and residential. The volatility of income returns was lower than the industrial sector overall.
Yields in the industrial sector usually exceed other sectors, so spreads against bond yields tend to be higher for this property type. This was certainly true in Europe in 2011. In eight markets compared by IPD, the spreads of industrial yields over national bond yields were higher than for office or retail properties in 2011.
This same pattern was also true for logistics compared with office and retail. However, the question is whether there are any measurable differences between spreads for logistics and spreads for the industrial sector overall.
In seven of the eight countries, logistics spreads differed no more than 50bps from overall industrial spreads in 2011. The exception was in the UK where the logistics spread was more than 100bps tighter than industrial. In fact, logistics spreads in the UK market have held at least 100bps tighter than the overall industrial sector in eight of the past 10 years. Such distinct long-term differences between industrial and logistics yield spreads in larger industrial markets like France and Germany, for example, have been much less discernible.
If UK logistics has emerged early as a relatively consistent outperformer, is it fair to ask if logistics is a sector poised for renewed investor interest in the rest of Europe, with the next investment cycle focusing on fundamentals rather than trophy properties?
From an investment perspective, the first half of 2012 delivered a 20% decline in the value of completed European logistics transactions, compared with the first half of 2011, according to Jones Lang LaSalle data. The demand from investors has been focused on northern European markets, notably the UK, Germany, and France, plus Benelux and the Nordics, and primarily Poland in the CEE region. There is almost no demand from international investors in southern European markets.
Investor demand has been split between those investors seeking core single-let assets, where there has been a flight to quality, as well as portfolios. With respect to the former, the focus has been on sourcing prime buildings in strong locations let to good covenants on long leases (for example, 10 years in Germany, the Nordics, and Belgium; six years in France; and 5-7 years in CEE), with demand from German open-ended funds, core institutional investors and third-party managed funds.
By contrast, private equity funds have led the chase to buy portfolios, and in this market ‘big is beautiful’, as scale offers a way of building a platform and market share while diversifying risk.
Eleanor Gilry is global head of sponsorship and membership at IPD. Doug Rowlands is associate director at IPD