Investment Actions

Logistics still logical

Aug 21, 2017
By Justin Brown

Warehouse build-out has room to run

Powered by the online shopping boom, warehouses continue to attract institutional capital. Real estate portfolio manager Justin Brown details how his team capitalises on the sector’s growth and anticipates its risks.


The meteoric rise of internet retailing has made logistics warehouses a fast-growing real estate sector. Investors in warehouses benefit both from structural (changing shopping habits) and cyclical (economic improvement) trends as the recovery in the global economy gains traction.

E-purchases in Europe are set to grow at a double-digit pace in 2017 to about €250 billion ($300 billion), the Centre for Retail Research estimates. The chart below highlights the speed at which e-commerce is progressing across different retail markets in Europe and beyond, with the UK, US and Germany leading the pack. Every additional billion dollars in e-commerce sales requires an additional 1.2 million square feet/111,000 square metres of logistics space on average, according to logistics real estate company Prologis.

Virtual shopping
E-commerce as a portion of total retail sales

Virtual shopping chart - logistics article

Source: Centre for Retail Research, 2015 and 2016 figures are actual reported data, and 2017 figures are forecasted data, based on sales-weighted retail transactions excluding vacations, autos, motor fuel and tickets. Any forecasts, figures, opinions, statements of financial market trends or investment techniques and strategies expressed are unless otherwise stated belongs to the author at the date of the relevant content. They are considered to be reliable at the time of writing, may not be all-inclusive and their accuracy and any forecasts are not guaranteed. They may be subject to change without reference or notification to you. This information should not be relied upon by the reader as research, investment advice or a recommendation.

Well-positioned warehouses are relatively cheap and easy to build, require little maintenance, and in the case of newer warehouses, generally command longer leases. In the UK, for example, lease agreements can be for 20 years or more. These leases often require tenants to be responsible for many of the operational costs and repairs. Tenants typically invest significant sums to fit out the units, hence their willingness to sign long leases. The leases may include fixed or inflation-linked annual rent increases, further enhancing the predictability of their cash flows relative to investors’ targets. The potential for stable, long-term revenues supported by healthy growth prospects suggest warehouses could be a good fit for core real estate portfolios.

The demand for logistics warehouses has made industrial investments the leader globally for real estate returns over the past several years. (See the chart below.)

Industrial strength
Global MSCI IPD annual total returns by property type

Industrial chart - logistics article

Source: BlackRock, MSCI Investment Property Databank (IPD) as of 31 December 2016. Index data provided for illustrative purposes only. It is not possible to invest in an index. Past performance is not a reliable indicator of future results.

What could go wrong? We anticipate increased competition as traditional retailers fight back against online businesses, potentially squeezing margins and weakening the credit quality of tenants. Another concern is that higher interest rates could lower commercial property values and therefore weaken total returns.

We track three major trends to stay on top of these risks:

    1. The need for last-mile delivery hubs. Consumer demand for faster service at a lower cost highlights the importance of warehouses that are well-positioned, e.g. near airports, motorways and other transport infrastructure with easy access to city centres. These may include new developments, existing warehouses or other types of assets that can be converted for retail distribution, such as obsolete light industrial sites.

      Proximity to urban areas where it is more difficult to construct new ‘build-to-suit’ warehouses can make the latter particularly attractive across Europe. For example, in Chingford, a suburb northeast of London, a relatively obsolete industrial asset was successfully repurposed into a distribution warehouse with a one-day delivery range of over 700,000 homes on behalf of one of Britain’s largest retailers, according to BlackRock estimates as of June 2017.

    2. The rise of logistics clusters. Customer demand for faster service may put a strain on profit margins unless retailers can control logistics costs. One way of enabling more efficient distribution is by locating suppliers, manufacturers or assemblers, and distribution centres within closer proximity to each other and to their customers. From this perspective, reshoring and near-shoring are increasingly a viable economic option among certain sectors and regions. Politics may help to accelerate this trend in the US and UK, with the Trump administration’s trade policies and the coming of Brexit potentially leading some businesses to take greater control over their supply chain through reshoring.

      To accommodate these structural shifts, the required range in the types of logistics centres is expanding. Again, properties in prime locations are positioned to command higher rents. For tenants, offsetting this cost is the potentially lower transport expenditure because subsequent deliveries generally cover shorter distances.

    3. Warehouse modernisation. Technology has afforded more flexibility as companies look for efficiencies. 3D printing, for example, has enabled production at a smaller scale closer to the customer. Advances in robotics coupled with rising wages in traditional offshoring centres such as China have allowed companies to contain labour costs when reshoring. Industrial robots are working side-byside with employees to improve staff productivity. For instance, robots can move items so that employees have shorter distances to walk to fulfil orders, saving labour and storage costs. Other developments to watch include the use of autonomous vehicles and drones to deliver packages, which may have implications for where units can be located.

      Implementation of the new technology requires a next generation of warehouses with modernised mechanical and electrical systems, and improved energy efficiency. Facilities that can cater to these more complex logistics processes may attract longer-term tenants and be more resilient to competition and obsolescence risk.

Investors who can capitalise on these trends, we believe, can gain access to a potentially attractive income stream at a time when yields in core fixed income remain under pressure.

 

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Justin Brown
Head of European Portfolio Management in BlackRock's Real Estate Team