The next priority for Segro’s CEO David Sleath is to scale up the REIT’s European urban warehousing portfolio to reap the coming growth in e-commerce.
Segro’s David Sleath says he cannot answer the question of how much further the spread of online retailing has to run. ‘That’s the $64,000 question,’ he replies. ‘No one really knows. It is nearly impossible to answer because we do not know how far online is going to go and when the penetration will level out.’
What he is certain of is ‘that it still feels immature to me, even in the UK which is the most developed e-commerce market in Europe. It feels as if there are still a lot of retailers which have not grasped the nettle – partly because they are still living with the legacy of 10-, 15- or 25-year leases that were signed. Now they are trying to adapt to a different structure and they are having to do it piecemeal because of those legacy leases’.
E-COMMERCE DRIVER
For Segro, this structural change is a massive opportunity. The group’s investors are delighted that e-commerce is the trend driving the company’s evolution. Their support has kept Segro’s share price trading at a strong premium when most of its UK-listed peers are at discounts. The stock has risen almost a third in the last year to the point that the company threatens to push aside British Land to become the second-largest London-listed REIT.
Investors applaud the delivery of the group’s biggest-ever development programme at a time of buoyant occupier demand, all the while maintaining a strong balance sheet with low leverage. During 2017, the portfolio achieved 13.6% capital growth which was a valuation surplus of over a billion euros (£965 mln) and the biggest one-year gain the company has ever made. The REIT completed 655,000 m2 of space, about three times as much development as it was doing three years ago. The pace continues, and, says Sleath: ‘With the pipeline we have, we are going to exceed that this year.’
Development has long been in Segro’s DNA, but Sleath remembers that the company was not always so loved and was something of ‘a sleeping giant’ back when the former Slough Estates was run by the redoubtable Sir Nigel Mobbs as a more diverse UK investor in industrial, office and some retail, with assets also in the US and continental Europe.
The groundwork for some of today’s stellar performance was laid in 2003 under Sleath’s predecessor, Ian Coull. Coull’s changes included the deal he considered the most significant of his property career, a successful takeover in 2009 in the depths of the recession of Segro’s UK industrial arch-rival Brixton Estates. Brixton owned an extensive portfolio of estates in some of the best industrial locations in greater London, including Heathrow Airport’s cargo area. Coull also hired Sleath, initially as deputy finance, then finance, director.
Since 2011, it has been Sleath in the driving seat. His first priority after he took over as CEO was to sell another £1.5 bn of property, including all the remaining offices, and reposition Segro as a pure industrial/logistics REIT.
Segro still develops and owns multi-let industrial, sometimes side by side with distribution ‘because we’re about providing the urban space that meets the needs of a city and the businesses which want to serve it, and we’ll take a view on local needs’, its CEO explains. Nevertheless, management’s primary focus now is expanding the logistics portfolio as fast as it can in what the team considers the best European locations.
BIG BOX AND LAST MILE
The existing €10.5 bn (£9.3 bn) of property under management in 10 European countries (December 2017) is over 40% by value in big box warehouses in major distribution hubs and out-of-town locations, and about 50% urban logistics sites (see charts, p15). Sleath says a particular strength is that ‘unlike most other players, we invest in urban locations, often the so-called last-mile delivery facilities, as well as big box logistics, and I think we are unique in having a big exposure to both’.
But the exposure is not evenly spread. Due to Segro’s history and the Brixton acquisition, its urban logistics portfolio is heavily skewed towards the UK, mainly London and the south east, and accounts for around £3.3 bn of total property value. London urban warehousing showed the greatest capital growth last year, of 17%.
A crucial next phase is to take advantage of UK ‘last-mile’ distribution trends rippling out across Europe to accelerate building on the continent and create a more balanced geographic portfolio. At present, Sleath says, continental last-mile assets only make up about €500 mln of the whole property portfolio.
When it comes to big box logistics, things are the other way around: the circa £800 mln UK portfolio is currently less than a third of the value of the £3 bn which Segro manages in continental Europe, mainly through the Segro European Logistics Partnership (SELP), its joint venture with Canadian pension fund PSP. ‘On the continent,’ Sleath says, ‘we’ve got this terrific big box portfolio which we’ve tripled since we created SELP with PSP at the end of 2013, through a combination of development and acquisition. We’ve got a good position in most of our markets and we’re building on that’.
15 EUROPEAN CITIES
To bulk up the UK big box portfolio, a drive is on via Segro’s two-year-old partnership with domestic specialist developer Roxhill. Their flagship site is East Midlands Gateway, 283 hectares (700 acres) off the M1 close to East Midlands airport. The first three pre-lets totalling 250,000 m2 were signed this year, with Amazon, Shop Direct and XPO Logistics.
Segro also continues to build on the position it has in London and south east urban warehouses, driving performance and redeveloping existing assets in locations like Heathrow and Park Royal, and developing new sites. The latter are mostly in north London and the east side of the capital where it has a 10-year exclusive agreement with the Greater London Authority called ‘East Plus’ to draw down 34 hectares across five sites.
‘We like urban locations because of the need for more distribution space to serve growing populations and because of the shortage of land to meet that requirement,’ Sleath expounds. The company wants to retain 100% ownership of its urban assets because ‘the economics of holding these investments and capturing the rental growth are compelling’.
For the urban strategy, Segro is focusing on 15 growing European cities where the e-commerce occupiers are expanding most rapidly: the seven largest in Germany, plus Warsaw, Paris, Lyon, Barcelona, Madrid, Milan and Rome, as well as London. The team has a ‘soft’ internal hurdle whereby they will only enter a country if they believe they can quickly get to €500 mln-€1 bn of assets. Sleath admits it is hard work: ‘Urban locations are very much local markets. You need to understand them and have people on the ground. The buildings are typically 3,000-7,000 m2, so each cheque you write is smaller than they would be for a big box facility.’
Could they not speed up through corporate acquisitions? ‘We made a corporate acquisition in Italy a couple of years ago,’ Sleath nods, referring to Vailog, a developer headed by Eric Veron which now also develops in other Segro markets. ‘It was a great fit and perfect timing in terms of Amazon and others like Yoox Net a Porter arriving in Italy and starting to expand.’
In January, Segro picked up a 20% stake in a small Parisian logistics company called Sofibus. Sleath would love a transformative deal in Spain, where after two years Segro has secured nine assets, ‘way below where want to be. We found some great partners to work with who have land or opportunities, but not one available to acquire’. Spain, he observes, is intensely competitive, but the upside is the size of the opportunity: ‘It’s a very under-served market; the quality of existing built space is generally poor. For example, in most European markets you’ll see 45-59% density, while in Spain it is 65-75% which means the loading space is more compromised.’
While the drive to get scale is principally through development, ‘we remain interested in acquisitions’, he continues. More often than not, however, the returns from buying dry product don’t work compared to the development pipeline yields of an average 7-8% on cost across the whole portfolio. Another difficulty is finding investments that meet requirements: ‘Multi-let industrial estates are being “re-described” by a lot of property people as last-mile delivery but they are generally not fit for purpose. There is such a shortage of space in some of these urban locations that anything with a flat floor and a few loading doors will work as a needs-must.
‘However, the retailers, logistics operators, and parcel delivery companies signing pre-lets with us want: more circulation space around the building, their own secure yard, a lot more doors, great road access. They want green power, fibre-optic cable. And that is a different product.’
ANALYST RATING
Sleath himself says he has still more to do at Segro. Some analysts are no longer rating Segro as a buy; while admiring the company, they feel the price at circa 650p is getting expensive. If Sleath presides over a climb back over the 700p level, he will have the satisfaction of proving them wrong and Segro being the first large UK REIT to finally, after 10 years, get back to pre-crash levels.
‘The beauty of our business’, he sums up, ‘is that we have the big box assets paying our overhead and we can go on and quietly build the urban logistics portfolio and get some scale there.’ If he delivers that scale he will have given Segro’s legion of fans exactly what they want.
Is the future multi-storey?
Asian cities like Hong Kong, Singapore and Tokyo pioneered multi-storey urban warehouses because of the pressure on land. With similar pressures in European cities, Segro has studied the lessons, talked to occupiers about what does and doesn’t work, and is developing two multi-storey urban logistics schemes, in Munich and Paris.
The Paris site is at Port de Gennevilliers, with access to central Paris and the western suburbs by arterial roads A15 and A86. Called Paris Air2, it is a 63,000 m2 two-level scheme and Segro brought completion forward to the end of this year after all the space pre-let rapidly, to retailers IKEA France and Leroy Merlin, at premium rents. In Munich, Segro pre-let a two-level, 15,000 m2 development at Daglfing off Munich’s A94 motorway near the airport to Amazon last November.
Yet retailers still prefer space on a single floor: ‘Amazon was happy to take a two-level building and the economics worked in Munich where rents are relatively high,’ Segro’s CEO says. ‘But if you had given Amazon the choice of having the same space all on a single floor in Munich, they’d have said: “yes, please”. There wasn’t a site big enough to give them what they needed, so it had to go up.’
The product is more expensive to build and has to be designed properly to get good rents, as Segro learned from its experience with X2, a two-level warehouse at Heathrow which the company inherited in the Brixton Estates portfolio. It took years to fully lease and has not achieved the rents that were predicted when it was originally developed in 2008. The access route to the top floor is compromised by a single, spiral ramp.
By contrast, the route to the second floor at Paris Air2 is a straight, 10-metre-wide ramp that allows vehicles to pass both ways, ‘so you can get large trucks straight up and down there, and the top floor has a massive yard’, Sleath explains. The scheme has 48 double-sided lorry docks on the ground floor and about half that number, 25, and single-sided, on the top floor. Other innovations include 85 electrical charging points – IKEA intends to transport goods using electric vehicles – a feature which Sleath says tenants ask for more frequently now.
London is an example of a European city where planning may be a big push towards building upwards as part of the trend towards densification. The draft London Plan wants to square the conundrum of doubling housing development while also at least maintaining supply of industrial and logistics space.
Overall, Sleath expects change to come relatively slowly, with Segro likely to develop only a handful over the next couple of years. ‘Only some sites will work and customers will need education or in some cases changes to their business models, to adapt. Multi-storey is a laudable objective, but it needs care to implement it.’
*****************
PERSONAL PROFILE
A chartered accountant who trained at Arthur Andersen where he was a partner, Segro’s CEO David Sleath says he feels more of a property person these days and that what makes him tick is how businesses work. He left Arthur Andersen in 1997 and became the finance director of listed engineering group Wagon. His interest in real estate started in 2005 when he joined Segro as deputy finance director, becoming FD the following year. He was appointed CEO in 2011.
