10 months ago • 6 mins
The past few years have been a rollercoaster ride for logistics real estate. First, there was the surging demand over the pandemic period and the rapid reconfiguration of supply chains. Then, there was the stomach-dropping fall in values in the second half of 2022, as interest rates increased sharply. Overall, we estimate that between June 2022 and March 2023, European logistics real estate values fell by around 20%, depending on location and quality. The decline was more pronounced in the UK, where values fell by as much as 30% in some areas. These are breathtaking numbers for a sector seeing strong demand and clear evidence of income growth.
Although the sector won’t be immune to a recession, the occupational market and long-term opportunities remain strong. That said, it will be critical to focus on asset quality and the fundamentals that are driving performance.
Some stability has started to emerge in 2023 and we are already seeing signs of investor interest returning in the UK and the Netherlands. Successful capital raisings have also provided evidence of longer-term conviction in the sector.
Supply chains were hugely disrupted by the Covid-19 pandemic, which reinforced the value of well-functioning logistics systems. Dare we forget the 2020 toilet roll crisis? But structural drivers have been in play for some time now and we have been recommending an overweight position in logistics real estate for many years. The changing fundamentals started nearly a decade ago, with the emergence of three key trends: de-globalisation, the birth of large-scale ecommerce, and the need for modern and energy-efficient supply chains.
Firstly, protectionist policies introduced in the US and the UK show that de-globalization has been in train for some time. Covid-19 further accelerated various aspects of this mega trend, resulting in the stress-testing of existing supply chains and more onshoring. Recently, we've seen more energy interdependency and a trend toward domestic production of car batteries, with manufacturing plants springing up in places like Norway, Sweden, Canada, and the US. But why does this matter for investors in logistics property? Well, the trend has shortened supply chains, which has led to new warehouse locations and more logistics assets being developed near end-users.
Secondly, ecommerce remains an incremental demand driver for the long term, despite a slowdown in recent growth. A slowdown was natural after the pandemic-related ecommerce boom, when online sales were artificially boosted by lockdowns. While much of this is related to the rise of Amazon, existing bricks-and-mortar retailers have also invested in supply chains to capture more online sales and to compete with Amazon. Launching online platforms might increase sales, but existing warehouse infrastructure is not suitable for this type of demand-driven distribution. Indeed, it has been proven to be unprofitable without necessary reconfiguration. Investment in new locations and modern warehousing is essential – particularly when it comes to handling returns, which can be as much as 60% of sales in the case of “fast fashion”, for example.
Thirdly, environmental, social, and governance (ESG) factors and carbon net-zero targets are becoming more important for both tenants and investors. Tighter regulations – such as the EU’s new Energy Performance of Buildings Directive – and more stringent valuation guidance from the Royal Institution of Chartered Surveyors, are encouraging investors to upgrade stock to improve efficiency. For tenants, soaring fuel bills are pushing them toward better-located and higher-quality buildings. The appeal of photovoltaic cells on a roof, for example, can potentially turn a cost into a positive revenue stream. The need to modernize warehousing will further widen the gap between future-fit assets and those facing obsolescence. In short, ESG considerations are now central to logistics real estate and commercial real estate more broadly.
Overall logistics leasing demand remains strong. Take-up across the 13 biggest logistics markets was 23% above the five-year average in 2022. Germany, Poland, France, the Netherlands, and the UK had the lion’s share of take-up at 78% of all leasing activity. The flight-to-quality theme continues to be key, with the vast majority of take-up in new warehouses.
Despite some pockets of increased development, such as in the UK, we expect the supply side to remain constrained in 2023 and 2024. The average European logistics vacancy rate fell by 1 percentage point to 2.9% in 2022, a record low level. In many markets, the supply of high-quality space is negligible and most leasing activity is decided during the pre-let or construction phases.
These pressures in the market have led to strong rental growth. UK industrial rents have increased much more quickly than in Europe. This is mainly due to intense demand and supply pressures around major cities, a lack of suitable sites, and the maturity of the UK market from an ecommerce perspective. In Europe, rents have only experienced strong growth over the last two years as the same demand and supply imbalances have taken longer to build. The pace of rental growth is likely to ease-off as market forces begin to normalize. But we think the supply chain reconfiguration taking place is a 10-year transition, and unlikely to be resolved in this real estate cycle.
Logistics real estate is well positioned to navigate the current high inflationary environment, thanks to rental growth, robust market fundamentals, and indexation in European leases. Backed by record-low vacancy rates and structural demand drivers, rental growth is expected to retain positive momentum in most UK and European logistics hotspots. Logistics space in good locations remains undersupplied, which means cash flows should be resilient and strong, with income growth persisting in the long term.
While lingering economic, political, and financial market uncertainties may disrupt investment trends in the short term, the ongoing ecommerce boom, onshoring, supply chain reconfiguration and modernisation should remain important drivers for logistics. However, going forward, as the outlook for logistics real estate improves, helped by important structural forces, we believe it will be more important than ever to focus on asset quality.
–Hong Bui is a real estate investment analyst covering Europe at abrdn, which owns Finimize. abrdn is a global investment company that helps customers plan, save, and invest for their future. This article was previously published by interactive investor, also an abrdn company.
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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.