There is still value to be had in logistics - but investors have to go looking for it. Shayla Walmsley reports

The problem with logistics as a sector is that its assets date fast. A report* earlier this year from logistics specialist ProLogis traced logistics from the mid-1990s, where it emerged as an investable sector in mainland Europe. The creation of the European Union in 1992 effectively rendered obsolete earlier custom-built assets, especially given the simultaneous trend for retailers to lease warehouses rather than owning them outright. As demand for older, smaller facilities declined, demand for large warehouses equipped for distribution across geographical regions strengthened.

Apart from rapid obsolescence, there are structural factors that make logistics potentially tricky to invest in. As the author of the ProLogis report, Lisa Graham, vice-president of European research, points out, other sectors favoured by institutional investors are concentrated in portfolios. "That's always been the problem with logistics - there are not that many investment-grade properties," she says.

That is one reason why the larger portfolios often favoured by pension schemes comprise transactions in all different sizes. Smaller properties might not be prime but they aren't necessarily obsolete. "The strategy is to move to large retail distribution centres but there are not enough of the 30,000m2 buildings for them. If you need X per cent of logistics in your portfolio, you'll have to mix them with the other stuff," says Graham.

If lack of available assets is one downside, the difficulty of categorising them is another. There is no super-prime in logistics. There is A, then B+, B-, and so on. Especially where sustainability is important, a modern but not state-of-the-art asset can be retrofitted to B+. But there is a grey area in the middle where "the assets aren't the newest but there is still value in them".

The problem is that different kinds of property are classified as grade B for different reasons. In the UK, for example, you get secondary properties in strategic locations where there are land constraints. That makes them competitive, but they might not have the most energy-efficient features.

"I wouldn't say sustainability is a threat to the logistics sector but during the recession occupiers saw it as a cost," says Graham. Now they're marketing themselves on their green initiatives. Sustainability will become a building standard across Europe because it's what occupiers are demanding. If they want natural light, then they'll get it. But they'll probably have to pay a higher rent for it and when business isn't good, they're less likely to want to pay it."

How much it matters depends on investors in the market. A German retailer distributing from the Czech Republic might well demand sustainable features - but the domestic retailer won't necessarily. "Sustainability just isn't critical in Central Europe," says Graham, adding: "Rents are low."

Demand picking up
Like other sectors, logistics has been dented by macro factors and by a retrenchment of Western European investors. Until the mid-2000s, investors in Central European logistics pretty much stuck to the capitals because peripheral markets, and non-metropolitan infrastructure, were less developed. When the economy started to become more robust in 2004-06, there was a movement out of the capital towards secondary cities. With the recession, investors retrenched and moved back to the capitals.

Macro factors, meanwhile, have had an adverse impact on investor confidence. The convergence of yields between prime and secondary cities ended when recession hit. But while it lasted, you had the same yield in Central Europe as in Western Europe. "That's when investors got a bit worried and why they pulled back," says Graham.

Given these caveats, it is perhaps surprising that appetite for logistics appears to be picking up. A survey conducted among 40 German pension funds and insurers by Ernst & Young, published in June, found that there was increased appetite for logistics, even if only opportunistically. Swedish fund manager Sveafastigheter, having raised €317m in equity from European and US investors for its third Nordic fund, is targeting Swedish logistics as one of its segments.

Yet the logistics market, especially in Central Europe, seems to be still dominated by opportunistic investors. Deka has put money into the sector and AEW was active at the end of last year. There are pan-European investors identifying the units, then approaching the owners of what are, after all, good income producers.

Even so, there is a gap between purchasers' and owners' price expectations, according to Kim Politzer, director of European research at Invesco, which manages the third BVK Europa-Immobilien-Spezialfonds for the €50bn Bayerische Versorgungskammer (BVK), an amalgam of 12 German public and sectoral pension schemes. BVK last April acquired a €37m Polish logistics hub leased to Tesco.

"In Western Europe, you'd be looking at yields of 6%. In Poland, it could be 7%," says Politzer. "But purchasers are likely to up their offers and come down to owners' pricing expectations because they're chasing yields. Investors are trying their luck on pricing. We've had unsolicited, opportunistic offers for some of our assets and we just had to tell them we're not distressed sellers."

Although Politzer sees increased German investor appetite for Central European logistics, she points out that they're after a specific type of product with a 10-year lease and a strong covenant with an international retailer such as Amazon or Carrefour. "They're not interested in short leases, multi-let units or domestic retailers," she says.

Alternative routes
BVK is getting an 8% yield on its deal by forward-funding and taking development risk - and taking advantage of the trend for tenants favouring design-and-build units, which they then lease back. Cautious investors will, more likely, take the forward-purchase route, where they don't have to buy the building unless it meets a series of specifications. The less cautious will opt for forward-funding, which carries more of a premium. "You'll see more of these kinds of arrangement," says Politzer.

The alternative is to go indirect - and potentially to embroil yourself in some pretty heated takeover activity. That is what APG did when, on behalf of a consortium of unnamed pension fund investors, it attempted to take over PEPR, a listed ProLogis fund.

Robert-Jan Foortse, head of non-listed European property at the Dutch pension fund manager, points out that APG had a long history with the portfolio, the assets and the manager. But once the fund went public it saw flaws in the governance of the fund that had to do with ProLogis's dual role as a manager as well as a shareholder. "APG tried for years actively to work to make changes but the company was insufficiently responsive," says Foortse.

The dispute was about more than theoretical shareholder control. Foortse is convinced that PEPR always traded at a discount to NAV because there was no way to terminate the management contract with ProLogis before 2016, and the management could not be removed even then without a vote that ProLogis owned enough shares to block. APG's action was aimed at closing the discount.

In the end, the action didn't work. When ProLogis wouldn't sell, APG did not have any other option but to sell its own shares.

"Would we do the same again? It depends. There are no other listed European logistics companies, but if the case were to arise again, yes. If you invest in European listed companies with exposure to logistics, you can get exposure - but it comes with other exposure," Foortse says.

* Obsolescence in Continental Europe's Logistics Property Sector, March 2011