Following a decade of bumper demand and returns, many experts are questioning whether logistics real estate assets have reached their prime or whether they still have further to run. Vivienne Bolla argues the latter.
Of all the real estate sectors, logistics has had a particularly buoyant decade or so. Perhaps some of this can be attributed to its relatively malleable nature – most warehouses are not tied to sectors or industries. It is also likely the result of it standing at the intersection of two mega-trends: urbanisation and online shopping.
Logistics assets, specifically warehouses geared around last-mile delivery and located on the edge of major cities, are benefiting from a surge in demand as traditional leases expire and online retailers step into the void as they try to optimise their supply chains and shorten delivery times. Urban dwellers have a seemingly insatiable appetite for goods delivered in double-quick time to their door and COVID-19 has merely accelerated what was an already well-advanced trend.
The death of the high street is one of the most talked about and well-telegraphed trends in recent history and exactly what happens to it is a subject for another piece, but needless to say it will involve more creative and experiential retail offerings. In the meantime, the roll out of free next-day delivery to more than 100 million Amazon Prime members announced in 2019 underlines its commitment to cementing its lead position as an online retail behemoth. The service will eventually cost about $800 million, the company estimated, but as Jeff Bezos says, “It’s a big investment, and it’s the right long-term decision for customers.”1
Companies are pouring an enormous amount of resources on the technology and infrastructure to raise service levels, reduce delivery times and lower transport costs. As a result, they are prioritising the development of urban (or ‘last mile delivery’) logistics and omni-channel capabilities, which refers to customer experiences across different sales channels. Underscoring that trend is a surge in demand for space from internet retailers and third-party logistics operators (3PLs).
These structural changes have prompted many investors to re-evaluate the role of the industrial sector within their portfolio. Investment capital has risen significantly, while yields have compressed relative to historic norms. Relative to other real estate sectors, most notably retail, logistics has brought above-trend returns in most European markets.
Despite the positive growth trajectory, however, investors should not become complacent. There are threats on the horizon that may hurt certain corners of the logistics sector more than others.
The restricted supply of e-commerce
While the rise of e-commerce has brought a structural shift in demand for logistics space, it hasn’t fundamentally altered the supply-side characteristics of the sector. It remains a supply-elastic sector characterised by short construction cycles and limited barriers to entry in most locations.
In fact, the combination of strong occupier demand and rising investment values has been favourable for development in recent years and an upswing in building activity has tended to keep a lid on rental growth. This is especially true in continental European markets (see Figure 1), though less so in the UK.
Figure 1: European logistics rental growth (pa), 2001-2024
Markets with greater barriers to new supply should be most resilient and offer the greatest potential for long-term, rental-driven investment performance. Barriers to new supply depend especially on land availability, which is determined by geographic constraints and competing land uses, as well as local planning and public policy trends.
The last mile advantage and urban demands
Supportive demand and supply factors are concentrated at the consumption end of supply chains, notably for the rapidly growing urban logistics (‘last mile delivery’) segment.
Consumer purchasing trends and technology are driving the e-commerce revolution
On the demand side, it is in urban areas where the structural changes associated with the rise of e-commerce are having the greatest impact on occupiers’ decisions, especially on how they’re spending along the supply chains (see Figure 2). Consumer purchasing trends and technology are driving the e-commerce revolution. With consumers increasingly demanding instant gratification when they make online purchases, distribution requirements are expanding rapidly in infill sites within major population centres in urban locations. In many cases, these sites are being chosen over lower-cost options, such as those in more out-of-town locations, due to their perceived additional value.
Figure 2: E-commerce supply chains changing overall economics and distribution of costs
In addition, urban logistics locations are generally more constrained from a supply perspective. The land they occupy has the greatest potential for a change to higher use and planning policy is often restrictive. These demand and supply characteristics suggest the possibility of strong rental growth and capital appreciation over the longer term, leading to our strong preference for urban logistics.
Though demand and supply factors generally favour urban logistics across Europe, it is nonetheless crucial to devise a framework to identify the most attractive investment targets.
On the demand side, the most important drivers for urban logistics are: access to a growing and affluent consumer base; access to cost-efficient labour; and readiness for e-commerce.
End of the line: Cyclical swings affect the bottom of supply chains
The growth of e-commerce has much further to run, but it is not the only driver of occupier demand in the industrial sector. Cyclical economic growth, measured by indicators such as gross domestic product (GDP), industrial production, consumer spending and trade volumes, also exert significant influence over the short to medium term.
The growth of e-commerce has much further to run, but it is not the only driver of occupier demand in the in
These demand drivers may increasingly become headwinds for the logistics sector. Slowing economic growth, driven in particular by a downswing in manufacturing and trade volumes, may reduce demand for warehouses and distribution centres. These cyclical trends have been worsened by the COVID-19 pandemic, which has exposed the vulnerability in global supply chains, and highlighted the need for greater supply chain resiliency. In such an economic environment, logistics assets down the supply chain are generally more exposed. Meanwhile, supply-side fundamentals are also less favourable down the supply chain due to restrictions on land availability as a result of geographic constraints and less competition for land use.
Buying in ‘bulk’: The case for national/regional distribution centres
Bulk distribution centres tend to be the initial stop for global supply chains within large geographies and are often located near the hubs of global trade. They act as a deconsolidation point serving other logistics facilities. To a greater extent, these facilities represent commodity space, so occupiers tend to be more footloose and price sensitive.
On the demand side, the most important criteria for occupiers both for national/regional and bulk distribution units are: access to deep, diverse and cost-efficient labour pool infrastructure adequate to support operational demand; notably power and fibre; and proximity to the transport network.
Asset returns can be enhanced and protected by investing in land-constrained locations that are nearer to the end consumer
The need to serve consumer demand places a constraint on where occupiers can locate, though less tight a constraint than in the urban logistics segment. As such, asset returns can be enhanced and protected by investing in land-constrained locations that are nearer to the end consumer.
Bulk distribution facilities also have wide location options and do not suffer from significant barriers to entry. Lower land constraints will impact land values and hamper rental growth prospects. As occupiers tend to have relatively more location flexibility, investors should be wary of high degree of substitution.
For landlords, it is critical to discriminate in favour of markets with some form of barrier to entry. We therefore tend to favour national/regional distribution assets over bulk distribution properties, though the latter may present opportunities if lease credentials are strong.
Logistics: Not without risks
As the pandemic has increased the uncertainty about the location of production globally, focusing on urban logistics assets that serve consumers appear attractive, particularly given they tend to be in limited supply. Occupiers are looking to generate significant value from their investments in this segment, suggesting significant potential for rental growth from assets that best meet their needs. However, the urban logistics segment remains a relatively small part of the sector. Lot sizes are small, potentially limiting its share in investment portfolios.
Therefore, investors also should consider assets further down the supply chain. The risk-return characteristics in national/regional and bulk distribution segments require more scrutiny, though, and obsolescence risk can increase.
COVID-19 will help establish the essential technical infrastructure that eventually forms a more robust digitised supply chain
A key unknown across the logistics sector is the potential impact of technological change. COVID-19 will help establish the essential technical infrastructure that eventually forms a more robust digitised supply chain. Though difficult to quantify, they have the potential to disrupt in three ways. First, more efficient use of logistics assets may result in less required floorspace per unit of economic growth. Second, the obsolescence risk may increase by more than expected. Thirdly, the importance of proximity to labour may be lowered.
These risks, however, can be minimised by investing in modern, well-specified assets in good locations and being within a short distance of consumers will continue to be key. For buy-and-hold investors, access to scarce, modern and build-to-suit assets may offer more stable returns over time. In the case of the fledgling urban logistics segment, where available stock is very limited, the potential to repurpose older buildings also offers an opportunity to add value.
Though many of the developments associated with the rise of e-commerce are novel, they can also be viewed as continuing the longer-run trend away from manufacturing/production functions towards distribution functions.
Raising the bar for faster delivery won’t come cheap for e-commerce companies. It will require a careful balance between the cost and benefit to maximise assets for the long term. Analysing logistics portfolios will therefore also require far-reaching analysis.