Pandemic leaves warehouses looking mispriced

As more of us work and shop from home during the pandemic, tenant and investor demand for retail space has fallen, while demand for logistics and warehouse space, in particular that close to major cities, has soared. Despite this additional demand, industrial rents have increased in only a handful of European markets and, in most cities, remain stuck near 2013 levels. Rental growth in the sector can often be constrained by the thin margins of warehouse tenants.

While rents have stalled, the logistics sector has nonetheless outperformed other European property segments. Investor appetite has pushed down yields from more than 7 per cent a decade ago to around 4 per cent. But this leaves limited scope for further yield compression to boost returns via capital appreciation. 

Where to look for rental growth

So that makes it important to concentrate on those markets and assets within the logistics sector whose rents can grow. High-specification, technology-enabled warehouses are one example. These are typically designed with high eaves that allow for tall racking systems and more use of robotics, and have the large energy supply that automation requires. Good insulation levels and cooling capacity are also sought after, for example, by grocers fulfilling more online sales and tenant companies wishing to provide a comfortable environment for their staff.

Urban logistics in supply-constrained areas should also do well as they are essential for same-day and next-day deliveries. The unstoppable rise of ecommerce mean occupiers are unlikely to want to reduce capacity, while planning rules and the limited availability of suitable sites restrict supply. In most cases, there are also valuable alternative uses for the land. Land values should therefore underpin pricing, while the growth of tenants’ businesses should eventually drive rents higher.

Local fundamentals matter. Supply in Paris, for example, looks very constrained. Add in the fact that French online sales penetration has just passed 11 per cent of all sales - the same threshold that was followed by a rise in UK logistics rents - and there are good reasons to expect Parisian rents to climb. We are less confident about other cities like Amsterdam or Warsaw. Amsterdam can be served quite efficiently by logistics space an hour away at Rotterdam, while Warsaw’s supply of logistics space is relatively elastic, moderating rents despite healthy demand.

Sustainability credentials matter

Premises with strong sustainability credentials are increasingly sought after. Around 50 per cent of European commercial property professionals report an increase in occupier demand for green-certified buildings in the 12 months to Q3 2020, according to a survey by the Royal Institution of Chartered Surveyors, with most of the rest reporting no change.

The same survey reveals that green buildings attract higher rents, and we’ve seen this to be the case in certain areas. For example, Fidelity International’s real estate team recently secured a 10-year lease on a new logistics development in Berlin at 5 per cent above the market rental value. The development has a gold certification from the German Sustainable Building Council (DGNB).

Understanding a tenant’s business

While these kinds of demand drivers matter for future returns, the strength of a tenant’s underlying business remains central to avoiding mispricing the credit risk, especially on long leases. Instead of chasing the longest lease offered at the highest rent, it can prove more effective to be flexible on initial rents to attract high-quality occupiers with strong underlying businesses that can stay for longer.

Understanding covenant strength is also becoming increasingly important, especially where owners rely more on rental growth than capital appreciation for future returns and after some of the measures required of landlords during the pandemic, such as allowing tenants to defer rent payments.

Ecommerce demand will continue to rise after Covid-19

The logistics property sector has had a very strong run in recent years, driven by ecommerce growth and now pandemic restrictions. While demand is expected to moderate this year following 2020’s highs, we think it should rise over the longer term. More than three-quarters of European ecommerce companies forecast revenue growth over the next five years. This won’t automatically translate into higher rents and prices for every warehouse, so investors should focus where fundamentals are strongest.