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QD view – The logistics paradox

The logistics sector is in a curious place right now. Comments from Amazon (the market leader in occupier take-up of logistics space over the last few years) about slowing the pace of its warehouse expansion have freaked the market. Meanwhile interest rate rises will almost certainly see investment yields erode as the cost of capital rises.

Consequently, we have seen the ratings of the logistics focused REITs swing wildly from large share price premiums to NAV to substantial discounts. This seems inconceivable when looking at the latest supply and demand data.

Around 15m sq ft of new leases were signed in the second quarter, bringing half-year take-up to a new record of 28.6m sq ft (surpassing last year’s half-year total of 24.5m sq ft). Online retail accounted for 18% of the total (down from 35% last year) demonstrating that the market is not reliant on a continued boom in e-commerce. There has been a resurgence in demand from the manufacturing and automotive sectors, while supply chain resilience and the need to hold more inventory becomes more important.

Looking forward, there is 19.4m sq ft of space under offer, according to CBRE and 200m sq ft of longer-term occupier requirements logged by Savills. On the supply side, there is just 18.4m sq ft of available space, according to Savills, and CBRE estimates that ready to occupy space remains at historically low levels of 1.2%.

A large portion of the under-offer space will be on pre-let new builds, but even so the supply/demand dynamics are very favourable and scream rental growth.

Delivery of new buildings is unlikely to keep pace with demand either. Savills is tracking 16.5m sq ft of speculative development due for delivery in 2022 and 2023. Given the wider economic context, new announcements are expected to tail off.

The logistics market, therefore, finds itself in an odd paradox of growing rents and an inevitable flat lining of capital values.

Investment activity across all real estate slowed in the second quarter, as capital markets reacted to the deteriorating economic outlook and interest rate environment. Total UK logistics investment volumes of £4.2bn in the half were down 19% on the same period in 2021.

Strong earnings growth among the listed logistics specialists will not be reciprocated in the NAV growth we have become accustomed to in recent years. However, as a long-term income investment these REITs may be looking attractive right now.

The market leader SEGRO is trading on a discount to NAV of 10.4%, while Tritax Big Box REIT is on an unbelievable 19.8% discount. These companies have a proven track record of growing rents through intensive asset management, and with a healthy occupational market, it seems inconceivable that capital values will fall, let alone by 10% or 20%.

In the urban ‘last-mile’ sub-sector (where Urban Logistics REIT operates) the supply/demand dynamics are even more acute. For the first time the majority of take-up was for ‘mid-box’ units (between 100,000 and 300,000 sq ft), while constraints on supply are severe.

The nature of urban logistics, being located close to large towns and cities, make gaining planning for this use class very difficult. In addition, build costs have been rising sharply, as well as the cost of land, resulting in the cost of building an urban logistics scheme exceeding the current values of a built property.

These fundamentals led to Urban Logistics REIT posting a like-for-like increase in rents across its portfolio of 16.4% in the year to 31 March 2022. The company has strong inflation protected baked into its leases, with the majority subject to annual open market rent reviews (76%), which mean the rent will rise to the higher of comparable deals in the market or indexation.

This, together with the management team’s razor-sharp focus on growing rents and adding value through asset management, makes the company’s 3.4% discount to NAV attractive.

QD view – The logistics paradox

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