The investor love affair with last mile assets has only just begun, according to leading voices in real estate.
Data shows that several markets across Europe are well-positioned to benefit from high growth economies and expanding online retail sales, with each €1 bn in online retail sales requiring around. 24,000 m2 of last mile logistics space, according to Knight Frank research.
While Covid accelerated growth in online retail and home delivery, subsequent macroeconomic headwinds have slightly curtailed spending volumes. Yet all European markets still have room for growth in terms of ecommerce penetration. Furthermore, several territories, which are significantly behind the more mature UK market, display a compelling need for large amounts of last mile infrastructure.
Institutional appeal
These dynamics have seen increasing amounts of investors enter the sector, including institutional players. Earlier this year, Canadian giant Ivanhoé Cambridge struck its first last mile deal in partnership with Urbz Capital, buying a property close to the centre of Munich benefitting from highway access.
The asset, situated in Karlsfeld, comprises a total surface area of 12,570 m2, with approximately 4,500 m2 of extension potential, located on a freehold site area of 23,800 m2. Post renovation, the property will comply with modern ESG standards and will include design specifications such as LED lighting & sensors, electric vehicle charging points, and other sustainable building installations.
Karim Habra, head of Europe and co-head of Asia Pacific at Ivanhoé Cambridge, says: ‘Due to the granularity of the assets, last-mile logistics is quite challenging for a large investor like us. We deemed it necessary to have a specialised partner to deploy our capital. Deals are often in the €10 to €50 mln range, which is why we invested into Mileway.’
Speaking further on the Urbz partnership, he adds: ‘We have already committed €400 mln in equity and we have identified targets at speed. Urbz is helping us access deals that are often under the radar for an investor of our size.’
Another generalist real estate investment manager, M7, also owned by a Canadian multinational in the shape of Oxford Properties, has been expanding in the sector. In March, M7 picked up four last mile logistics properties in Portugal, via three separate off-market transactions, on behalf of funds managed by Blackstone.
The assets, which comprise a total of 36,400 m2, are located in Porto and Lisbon, and were acquired from Santander Asset Management, Interfundos, as well as DSV. M7 is pursuing an active asset management strategy aimed at driving the income profile of the assets by leasing up the existing 16% vacancy within the properties and reducing net operating income leakage.
David Ebbrell, M7 CEO, says: ‘The way that goods are distributed to customers has changed significantly, accelerated by Covid, and we continue to believe in that as a strategy. Some 60% of our assets are urban logistics and warehouses, across the territories of the UK, Netherlands, Spain, Ireland, Portugal, Denmark, France, Germany, Croatia, Hungary and Poland. So we get a very interesting view and data from an occupier perspective thanks to that range.’
Ebbrell notes that demand remains strong across each of those markets. ‘Tenants don’t have enough space, they keep paying their rent, and are looking to partner with us for the long term.’
Specialist approach
There are also specialist investors who are focusing wholly on the sector’s potential. Valor is one such firm, which launched in 2016 to ‘capitalise on the supply and demand imbalance in urban logistics’. A big part of Valor’s thesis is the fact that ecommerce sales in the UK, France and Germany are forecast to grow at a combined compound annual growth rate of 8.5% from 2020-2025.
The firm is also betting on the fact that what it calls ‘new strains’ of demand for same day delivery are creating an expanded market for last mile logistics properties.
Despite all this, the last 18 months haven’t been without their challenges. ‘It’s been a year of subdued activity,’ says Christian Jamison, the firm’s managing partner, when discussing recent transactions. ‘In the second quarter of 2022, interest rates started to rise, then the UK mini budget in October caused turmoil in bond markets and saw a run on sterling – it’s taken a while for things to stabilise. The outcome was a rapid repricing in the UK towards the end of last year but subsequently we have seen prices steady and in some cases recovering, with cap rates coming off their highs at the end of the last year.’
Jamison notices too that the ‘institutional effect’ is brewing. ‘There continue to be a lot of investors targeting the market, the most active buyers today are those that feel under-allocated to the sector and see this as an opportune time to increase their exposure.
‘In the UK you have the highest financing costs in Europe, and you still have the highest inflation. Interest rate uncertainty makes it challenging to underwrite deals, and yields are still quite low. Everyone said that inflation would be transitory, but that’s not how things worked out.’
Jamison thinks that while interest rates should soften eventually, they will stay higher for longer. He adds: ‘They’re not going to get back to zero in a hurry. The economic consensus is often wrong, so interest rate forecasts are not worth basing your strategy around.’
Despite the needle moving the most quickly on UK prices, he is still taking a cautious approach to inking deals. ‘The outlook is uncertain, and when you’ve got five yearly rent reviews, capturing that reversion takes time and puts pressure on your debt service. But overall, we still really like the UK market, where the urban logistics supply-demand imbalance is particularly acute.’
European promise
The Continent, meanwhile, ‘is a little easier right now, because the price adjustment is now coming through after more gradual adjustment.’ Here, Jamison says Valor is benefitting from lower interest rates and inflation-linked income. All that means that the firm is slightly more active in Continental Europe currently than in the UK, although the UK was previously the firm’s biggest market. Key markets are currently ‘Paris and Berlin, although we are also looking at new geographies including the Netherlands and Northern Italy. Inflation-linked leases in the EU benefit from yearly revisions, which is a big pull right now.’
He notes that France and Germany are also still significantly behind the UK when it comes to ecommerce penetration and adds: ‘We have generated some of our highest returns in and around Paris because of these factors, so we have doubled down and expanded the team including opening a new larger office.’
Part of ongoing asset management has included debt refinancing, something that Valor recently undertook on some German assets.
He adds: ‘So far, we are still seeing reasonable liquidity in the debt markets. We are in a fortunate position as we have a subscription line we can draw upon to acquire assets; generally we are aggregating a number of assets and then refinancing them as part of a portfolio. Our assets are very granular and that diversity of income with growth potential is attractive to lenders.
‘Overall, the bank debt is there, but the constraining factors are the interest cover ratios. You still have this dilution to cashflow returns as the swap rates are c.4%, plus the margin and arrangement fees. That stacks up to quite an expensive debt proposition vs net initial yields that are likely to be lower. But, as long as you can get to 1.25-1.5x interest cover ratios or more upon stabilisation, you should be ok.’
On the occupational side, Valor is still seeing impressive leasing dynamics. ‘We have virtually no vacancy,’ Jamison enthuses. ‘The rents we can achieve are very good. Overall, occupational demand is great – what we have seen so far is really a capital markets issue.’
While some big box occupiers have slowed down their expansion plans over the last 12 months, Jamison notes that ‘last mile is a different story’. He adds: ‘These are smaller boxes – they are about efficiency. We have spent time analysing this, trying to get under the skin of the affordability and the rent growth story. Rent is still a small fraction of occupiers’ costs, so they prefer to be closer as what they save on fuel / extra drivers more than makes up for higher rents.
‘So overall, the occupier demand for these truly urban logistics assets remains very strong. There’s a real lack of supply, and that’s what excites us. We still see great prospects in the sector.’
Development dynamics
Finally, development is still very much on Valor’s radar. ‘We have a strong appetite for development if we can get hold of sites,’ he says. ‘While prices for logistics assets increased rapidly over the past few years, land prices shifted even more quickly. We are often competing with residential developers for sites as that can sometimes be a more lucrative end-use.’
He adds: ‘We never underwrite a change of use, but if we encounter a situation for example where the council says they want to zone an area for residential, we might sell to a residential developer. We have a site in West London which will probably go that way in a few years, but that’s never our base case – we always think as a logistics investor.’
Across its entire portfolio, Valor is attempting to be ahead of the curve when it comes to matters of ESG. ‘ESG is front of mind for everyone with the EPC changes coming through. We are always looking for ways to improve buildings, and a part of this is buying standing assets and repositioning them. There is a ceiling to the rating we can achieve that way, but it’s better than knocking down something that is functional and starting again. We feel we can make a big difference on the asset side by investing in energy efficiency.
‘On the same note, we have obtained green loans in France where we executed plans to improve the efficiency of assets, and are committed to the S as well across our portfolio. We have been working with school-aged children through the Academy of Real Assets in the UK to help young people get into the industry, which is very worthwhile and hopefully has a lasting positive impact on the industry by attracting a braoder pool of talent.’
