Logistics Special: No floor in sight as demand leads to record low yields

Is the logistics bubble about to burst after a record year? The outlook suggests yields could continue to fall, reports Paul Strohm.

It is no secret, 2020 turned out to be a good year for logistics property which was not the case for all other areas of real estate. 

Demand from occupiers has been reflected in demand from investors. But with such a rush to the sector, there could be a day of reckoning around the corner.

“Clearly last year, March, April, going into May was not good, we basically put all new development on hold and our acquisition programme slowed down entirely,” Ben Bannatyne, president, Prologis Europe explains. “However, after the initial panic and, more importantly, once we could see where our customers were going, we ramped up again pretty quickly.”

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The end result, he says, is that Prologis Europe finished 2020 slightly behind in terms of deployment and development, but roughly on track with operating KPIs [key performance indicators] such as occupancy. However, in 2021 customer activity has ramped up again, Bannatyne adds.

“There is lots of build-to-suit activity across Europe, occupancy is trending upwards in most countries, with rent growth again, and markets like Germany are extremely strong. I think we are back to where we finished 2019 and e-commerce is a major play.”

Record-breaking year

Robert Dobrzycki, CEO Europe at Panattoni Europe, says that while 2020 was an extraordinary year from many points of view, it was a record breaker for Panattoni in terms of development volume, tenant demand and investment volume. “We have very strong demand from e-commerce with pan-European rollouts of many large customers,” he says.

He adds that in terms of investment it “feels amazing”. “We feel very excited about what the future could bring.”

‘There is lots of build-to-suit activity across Europe, occupancy is trending upwards in most countries, with rent growth again, and markets like Germany are extremely strong. I think we are back to where we finished 2019.’

Ben Bannatyne, Prologis Europe

While 20 years ago, logistics was seen as the poor cousin of the real estate market says Ian Worboys, MD and head of European logistics of Trammell Crow Company, he adds that total returns are now, under any dynamic, “the best performing, so people are moving into this market”. 

The effect of that is yields in some cases are being compressed to around 3%, Worboys says. “You wonder if, with a long-term Amazon [as tenant], it could dip below 3%. There is a huge appetite for logistics. A lot of investors all over the world cannot get the returns they want, so logistics is one of the few markets that is still growing.” 

He adds that the huge growth in e-commerce over the next few years is being followed by the money “and that is bringing pricing in”.

There is room for newcomers such as Trammell Crow to enter the sector in Europe, says Kevin Mofid, director research, at Savills. Mofid says the statistics confirm that the collective logistics investment pie is getting much larger so there is more to go around and thus new entrants have an opportunity “to get a slice of that pie”.

Drawing from UK statistics, Mofid explains that in January 2021 the total of the requirements for logistics was 223% higher than in January 2020. “Of course, not every requirement results in a deal but that is a good proxy to show you the occupational interest which then has knock-on impacts for the development and capital markets community.”

Unprecedented low yields

The demand has led to unprecedented low yields with no apparent floor as yet, and no apparent risks or upward pressures in sight.

“You need to ask what are the property market conditions that would need to exist for yields to move out,” Mofid says. “Are we going to see a supply surge or is there going to be overdevelopment of speculative space?”

‘Public authorities are more inclined to grant permits knowing that e-commerce has become a vital element in keeping economies up and running.’

Wulf Meinel, StoneVest

“There may be certain micro-markets where the supply does rise and vacancy rises, but on the whole I don’t see a development-led rise in vacancy occurring. The question then becomes are we going to see secondhand supply rise with the prevailing economic conditions?”

He points to the UK example where two major retailers have recently gone into administration but their demise only increased vacancy by 0.3%. “You would need to see huge structural failure for secondhand supply to have a structural effect on vacancy,” he says.

Bannatyne says the risks to the sector seem minimal at present. On the supply side there is little funding available for speculative development which is a restraint on overdevelopment. Meanwhile, demand continues to be stable. “I do think there will be a slowdown in consumer spending which will be relatively short term, so we don’t really see a doomsday scenario,” says Bannatyne.

Furthermore, one effect of the recent health crisis could be an easing of the planning and permitting process, according to Wulf Meinel, founding partner of asset manager StoneVest.

“Covid has led to a softening in that respect. Public authorities are much more inclined to grant these permits knowing that e-commerce has become a vital element in keeping economies up and running and gives them a certain free hand to keep retail shops closed.”

Meinel says that large Amazon warehouses would have faced significant political hurdles two or three years ago. “The same goes for battery factories. Suddenly the consumption of greenfield for these purposes in densely populated countries such as Germany, France and the UK is less of an issue.”

The experience varies though. Bannatyne says he is yet to see an easing of the difficulties in obtaining permitted land. “Our biggest challenges at the moment are finding land and getting that land permitted. 
It is taking a hell of a lot longer than it used to to get the permits through so you are having to add six-to-12 months to development, which is expensive.”

‘A lot of investors cannot get the returns they want, so logistics is one of the few markets that is still growing.’

Ian Worboys, Trammell Crow Company

Online activity offsets overall fall in retail spending

Two key indicators, unemployment and consumer spending, would traditionally be used to predict the path of demand in an economy. But Savills’ head of logistics and industrial research, Kevin Mofid, questions whether these indicators can now be relied upon to forecast demand for warehouses and logistics buildings.

In the UK at least, online purchases are now 28% of total retail spend. But as far as logistics property is concerned, Mofid says the effects of a fall in the overall level of retail spending are being offset by the increasing proportion that is being spent online.

Mofid points out that in 2020, take-up of logistics space in the UK was 50.1 million sq ft (4.6 million sq m), an 80% increase on the preceding year. Meanwhile, the vacancy rate fell to 5.71%. In 10 years take-up has increased by 127%, he adds.

In 2020 in the UK, take-up of space built speculatively hit a record 10.8 million sq ft (1 million sq m), the largest amount ever. Amazon accounted for about 25% of this in terms of space. In terms of number of deals, however, it represents about 11%. Meanwhile, third party logistics providers (3PLs) were responsible for nearly 10 million sq ft (929,000 sq m) of take-up.

‘You need to ask what are the property market conditions that would need to exist for yields to move out. Are we going to see a supply surge or is there going to be overdevelopment of speculative space?’

Kevin Mofid, Savills

And the upward trends seem likely to continue. In a recent survey undertaken by Savills 90% of respondents said that they would need more warehouse space within the next two years.

Mofid says the pattern of demand is similar across much of continental Europe, where demand increased 8% year-on-year in 2020 to reach 30 million sq m. Not all European markets have performed in the same way and while the UK, Netherlands and Poland were all strong, demand was more muted in France and Czech Republic.

But a further positive factor is that the vacancy rate is so low. In the UK vacancy is currently about 5.7% while it is around 5.3% in Continental Europe. Mofid points to research which indicates that rents never increase when vacancy exceeds 12%, so logistics seems to be comfortably in rental growth territory.

The investment market for logistics property is correspondingly buoyant and in Europe increased 5% year-on-year in 2020 to reach €39 billion.

Demand for warehouse space will increase further: Mofid says that once online retail accounts for more than 10.7% of total retail spending, demand for warehouse space starts to surge. And he points to Prologis research that states that for every €1 billion increase in spending, there is a requirement for a further 750,000 sq ft (c69,700 sq m) of logistics floorspace.