Just how long can Europe’s logistics boom last?
Investor appetite for logistics assets is at record highs and rental growth continues, but experts are sounding a note of caution, reports Paul Strohm.
The unprecedented surge in the fortunes of the logistics real estate sector that have occurred over the last two years as the health crisis intensified existing structural trends naturally prompt the question: “Where next for logistics?”
The last year, in particular, has raised the bar for the sector by most measurements.
Sally Bruer, head of EMEA logistics and industrial research and insight at Cushman & Wakefield, describes the period as “the most extraordinary 12 months”. She says that “in terms of occupational demand it was the strongest year on record, at 46 million sq m across Europe”.
Occupier demand was very high for all types of space, but particularly for new build and modern buildings, which also fuelled enormous amounts of development, particularly speculative projects, “and in areas which have previously seen little speculative development in recent years, or ever”, Bruer adds.
But development has not kept up with the surge in demand and vacancy has diminished, routinely to less than 3% of stock. Consequently, “rental growth has been absolutely extraordinary”.
Investor appetite hits new heights
“Nearly every market has seen rental growth, particularly markets across the UK and particularly London,” notes Bruer. In some cases this has resulted in increases of more than 50% annually, she says. This growth has driven investor appetite to even greater heights: “More and more records are tumbling on the capital market side.”
‘The mechanics for developers have changed and any surprises were covered by yield compression, but this cannot continue forever.’
Frank Pörschke, CEO, P3 Logistic Parks
The volume of investment into the sector across Europe was in excess of €65 billion in 2021 – typically, €40 billion might be expected. “We anticipate that there is far more capital continuing to target the market, particularly for portfolios which were more than 50% of the deal volume last year, particularly on the larger side,” says Bruer.
The trends have been illustrated clearly in Germany. “We had an investment volume a little bit over €9 billion last year, which is a 23% increase, year-on-year, the strongest ever recorded,” says Michael Bohde, head of Germany, Cromwell Property Group.
The sector has become the second-largest asset class behind offices, with a market share just above 15%. “There is shortage of product and there will be continued pressure on pricing,” Bohde adds. “That said, this pressure will be more or less pronounced across the risk/return curve in Germany. It will be a little less pronounced for core logistics and is likely to be a little more pronounced for core-plus and value-add product.”
Rent increases are beginning to justify some of the cap rate compression, says Rory Buck, managing director of Clarion Partners Europe. “There’s significant demand and we’re seeing rental growth in the statistics today. That, I think, is a little different from what we’ve seen over the last few years.
“Investors are now more confident to underwrite that in their models. I think that will have a tightening effect on yields, but you also need to be cognisant of lending rates. Those have changed dramatically over the last couple of months. That will have a negative impact on yield. So these things need to be balanced.”
‘Nearly every market has seen rental growth, particularly markets across the UK and particularly London.’
Sally Bruer, Cushman & Wakefield
The extent to which the logistics sector’s heady metrics are sustainable depends largely on occupier demand, says Frank Pörschke, CEO of P3 Logistic Parks.
The market has not yet factored in any likely repercussions of Russia’s invasion of Ukraine on the supply chain, on demand or on costs. But Pörschke says that assuming that in the medium term, the wider economy does well, “we do see very helpful, healthy structural trends”.
However, he does sound one warning. “I think the yield compression we have observed in the past year has been a cover for lots of challenges. Yield compression was basically the automatic solution for many things.”
He adds that rising values created by yield compression have masked construction cost increases, which have been significant over the past two years – 20% to 30% in some markets – as well as land price increases.
Changed development mechanics
“So basically the mechanics for developers have changed and any surprises were covered by the yield compression but, by definition, this yield compression cannot continue forever. And, in an environment where we have more inflation, where central banks in Europe are slowly easing into a slightly more restrictive direction, this will not be the solution for the next year.”
If this is the case, either development will become less attractive for developers or there must be a readiness to pay higher rents.
‘We see more and more difficulty with the situation, construction prices and scarcity. It’s definitely not an easy situation.’
Raimund Paetzmann, Zalando
The extent of that dichotomy is emphasised by Raimund Paetzmann, vice-president corporate real estate, at Berlin-headquartered online fashion retailer Zalando. “We see more and more difficulty with the situation, construction prices and scarcity. It’s definitely not an easy situation. When you do negotiations with general contractors, within two months of negotiation, the price rises 5% so it’s a really challenging time.”
Paetzmann says it will thus be challenging to see how the company’s goals can be fulfilled, how it can find the right properties and retain its workforce. “Everyone has to stay reasonable so that we are not overheating the market through too much competition,” he says.
While some market variance up or down is normal, he says, “we have to stick to market fundamentals and what the rent actually is for a location”. Paetzmann stresses that the market should not turn into an auction between occupiers, “because then we’ll be creating a bubble and people will suffer in maybe three or four years”.