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March 8, 2022

German logistics – Diversify for performance

Michael Bohde, Head of Germany, Cromwell Property Group

German logistics is hot. Occupational activity has been record-breaking as rising ecommerce penetration and the shift towards supply chain resiliency has supported demand. According to our calculations an additional two million sqm of logistics space alone will be needed in Germany over the next five years to accommodate ongoing growth. Given land supply is highly constrained, this bodes well for future rental growth prospects.

Reflecting this, investors are acquisitive. Last year some €28bn was sunk into European logistics according to RCA. German logistics/ light industrial transaction volumes in 2021 equated to €9.2bn according to Colliers or €10bn according to CBRE. With so much capital chasing such limited stock, yields are under pressure. Over the last year prime logistics yields have compressed by 40 basis points to reach 3.0% in Q4 2021 according to CBRE, and if their forecasts prove correct further moderate sharpening is likely.

/Logistics-warehouse

This leaves many investors pondering how they can benefit from the sectors growth prospects without compromising on well-priced entry yields. In our view, informed investors have two routes in particular to secure more value: increase the light industrial allocations or gain pan-European diversification.

Light industrial shift

Light industrial stock comprises space used for manufacturing, production activities such as part assembly and repackaging or research and development. Typically light industrial has higher office content than logistics stock and may comprise smaller assets or multi-let tenancies. Like logistics it benefits from exposure to cyclical economic and structural growth in online retail and supply chain recalibration but at more compelling entry prices.

Light industrial accounts for a large proportion of German industrial and logistics supply. Much of this is situated in urban areas where land competition is intensifying due to urbanisation. This underpins land value and offers future upside potential from densification for either co-located light industrial/logistics with other mixed-uses, or potential conversion to other uses entirely such as residential. This has the potential to deliver better performance.

Unlike logistics though, light industrial stock is far more differentiated and bespoke to the occupier and purpose. To acquire stock with resilient income and growth potential, investors must apply a granular approach to stock selection. Although granularity is needed, the right specialist can still build scale quickly, comparable to a logistics portfolio. Partnering with investment managers who understand local markets, are well connected to occupiers and can make informed decisions is vital.

 

Logistics Pan-European diversification

Another option for distribution-seeking investors is to expand into other higher-yielding European markets. Prime logistics yields of 4.25% in the Czech Republic, 4.35% in Poland and 3.95% in Italy are clearly appealing relative to Germany (figure 1). Occupier demand for quality stock in these markets is rising and land supply in the top locations is tight.

Not only will pan-European diversification bolster distributions, but it also spreads income risk by gaining exposure to assets and occupiers subject to different country dynamics. This reflects both the unique economic prospects of each European country and, of particular relevance to logistics performance, differing stages of online retail market maturity.

Countries with ecommerce penetration of below 10% of total retail spending are immature. Analysis from mature markets such as the UK and Netherlands demonstrates when penetration rises above 10%, logistics occupier demand also accelerates. The demand impetus typically proceeds faster than the supply response, especially given it is increasingly hard to find sites and gain permission for new logistics development, leading to rapidly escalating rents. Rental growth tends to endure when markets reach maturity above 18% penetration as occupiers seek to consolidate their distribution networks to maintain market share.

European-country-level-ecommerce

Many European countries have recently entered the maturing stage of ecommerce growth (figure 2). In addition to Germany (16% online penetration in 2022 according to CBRE) these include the large Italian (10%) and Central and Eastern Europe economies (14% and 17% in Poland and Czech Republic respectively). This bodes well for future rental growth prospects in these countries and those who invest there.

European-ecommerce-market

Wise pan-European diversification requires a robust understanding of local market dynamics. Whilst logistics stock is fairly generic, local country particularities have a significant impact on return prospects and requires granular market expertise in order to make informed decisions.

Broader allocation will deliver income

In summary, we expect that compelling long-term fundamentals in the logistics sector coupled with low distribution yields in core logistics will prompt a growing number of investors to diversify. Diversification will encompass acquiring higher-yielding light industrial stock in Germany which benefits from exposure to similar occupational drivers and often has underlying land value. It will include European diversification to gain exposure to stock likely to benefit from rapidly escalating occupier demand at more compelling yields. Such diversification also spreads risk and smooths income returns.

Effectively executing a diversification strategy of this nature requires partnering with an informed investment manager with a true pan-European presence. This is a sophisticated approach which relies upon detailed knowledge of evolving occupier demand and how that relates to real estate. Local markets must be thoroughly understood in order to understand their unique characteristics and identify the most attractive investment opportunities. Local relationships with landlords and occupiers will also help to maximise performance potential.

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February 9, 2022

Retail revival – Uncovering value in a changing landscape

In Cromwell’s latest briefing note, Tom Duncan and Alex Dunn from the research and investment strategy team discuss the outlook for the retail sector. Whilst it has faced challenging short-term conditions, the prospects for physical retail that has a role in an e-commerce-infused world are bright. They discuss the investment strategy implications of this and the opportunities to uncover immediate and long-term value.

The briefing note can be found by clicking here.

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November 10, 2021

Offices 2025 – Research Briefing Note

The enforced mass homeworking caused by the pandemic has viscerally demonstrated that in today’s tech-infused world knowledge-based ‘work’ is an action, not a place, and it need not necessarily be performed in an office. This has triggered much public debate on the purpose of offices and what future they might have. In Cromwell’s latest briefing note, Tom Duncan and Alex Dunn from the research team examines these recent events, their impact on the sector and what this means for the future role of offices and the resultant implications for occupier demand.

The briefing note applied to the European office market can be found by clicking here.

The briefing note applied to the Australian office market can be found by clicking here.

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October 22, 2021

Land scarcity and eco-issues cloud booming Dutch market

Lack of land and product, growing environmental constraints, and intense competition for plots and assets – the conditions for entering and expanding in the Dutch logistics market would appear far from ideal. Yet the droves of foreign developers and investors which have made their way to the Netherlands in recent years – and are still arriving – are evidence that there is still good business to be done. Head of Benelux, Wouter Zwetsloot recently participated in ‘The State of Logistics 2021: Logistics in the Netherlands’ panel discussion hosted by PropertyEU where he, alongside other industry experts, gave their insights why the investment case for Dutch Logistics remains rock solid.

The full article can be read here.

Land-scarcity

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September 22, 2021

European Inflation – Research Briefing Note

In Cromwell’s latest briefing note, Tom Duncan and Alex Dunn from the research team examine European inflation. Together they discuss the heightened concern regarding the inflationary outlook and the potential consequences for real estate.

The full briefing note can be found by clicking here.

European-inflation

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June 30, 2021

Engineered timber and the drive for more sustainable buildings

Alex Dunn

 

Climate change continues to shape the values, choices and investment decisions of the real estate industry.

In this article Senior Research Analyst, Alex Dunn, discusses how advances in engineered timber and construction are allowing asset owners to substantially improve the environmental performance of their buildings, while simultaneously, also meeting investors requirements for capital to be deployed in a more sustainable way.

Real estate positioned to reduce carbon emissions

Real estate accounts for approximately 36% of global energy consumption and 40% of total direct and indirect CO2 emissions, according to JLL. Left unchanged, the global trend towards urbanisation and the ever-increasing demand for new building stock will see these numbers continue to rise.

Unsurprisingly, the United Nations Environment Programme (UNEP) estimates that the real estate sector has the greatest opportunity to reduce greenhouse gas emissions compared to other industries, with potential energy savings estimated to be as much as 50% or more by 2050.

Government policies regulating the energy performance of new buildings are a powerful way of reducing emissions and are being introduced by an increasing number of countries. Leading cities are also introducing city-level regulation at a fast rate. Paris has a net zero carbon goal for 2050 and Amsterdam plans on being fully electric by the same time. The European Union has also established the ‘Green Deal’ in order to make the Eurozone climate neutral in 2050.

Legislation is increasingly likely to support sustainable assets with future regulatory and tax changes favouring sustainable investments and disadvantaging assets that cannot demonstrate compliance. It is notable that a survey carried out by Macquarie Infrastructure and Real Assets in 2020 found that 91% of global institutional investors expected to increase their level of investment into ‘sustainable’ real assets over the next five years.

 

Engineered timber buildings are becoming increasingly popular

In many countries, construction is a way to accelerate the economic recovery from the pandemic but it’s also a major source of carbon emissions. One way to bridge this issue is to increase the construction of more sustainable buildings.

Engineered timber buildings tick this box, and a combination of technological innovation, greater sustainability and reduced costs has seen the number of such developments increase globally.

Construction using concrete and steel is highly carbon-intensive, compared to trees which capture and store carbon dioxide as they grow, making timber a far greater climate-friendly building material. Timber construction also uses materials derived solely from managed fast growth plantations meaning construction is sustainable and does not rely on harvesting old-growth forests.

The rapid development in the market has been made possible by the technological breakthroughs of new engineered wood products, such as Glue-laminated Timber (Glulam), Cross-laminated Timber (CLT), and Laminated Veneer Lumber (LVL).

These engineered timber products are all versatile and support innovative flexible design and architecture approaches. It is this flexibility, combined with their increasing popularity and reduced construction time that has made engineered timber competitive with more traditional concrete and steel structures.

In Europe, the market for engineered timber construction has been growing by roughly 8% (€5 billion) a year and is expected to accelerate to €10 billion a year by 2030. These figures concern primarily multi-storey buildings, however, and with the inclusion and addition of wooden frame buildings and/or detached houses, the size of the investible market increases significantly.

The engineered timber market in Europe is concentrated, with the top five markets comprising more than 80% of activity. Germany is the market leader, accounting for 22% of construction, followed by France and UK, both with 16%, the Nordics (Finland, Norway, Sweden) collectively account for another 16% and then Austria with 12%.

Conclusion

The ongoing development of timber-based construction creates an attractive and expanding investment opportunity. Whilst these developments broadly maintain all the well-established features of a real asset in terms of return and risk, they also provide additional sustainability benefits.

Engineered timber buildings are also often perceived as superior by the people living or working in them. There are several studies which reference the health benefits of timber looking at both measured and perceived indoor environment quality. There is also evidence of human health and wellbeing benefits based on wood’s biophilic properties, according to Dasos Capital.

These benefits will help drive greater tenant retention and income resilience, as buildings increasingly need to reflect the ethos of the brands that operate within them. Perhaps more importantly to remain ‘investable’, the buildings must be able to demonstrate their sustainability credentials in order to maintain their value over the investment and asset lifecycle.

Our ongoing commitment to ESG

Cromwell has formalised an ESG Strategy for our global business. This strategy includes targets that are crucial to our future, including decarbonising our business toward net zero and setting new baselines for areas – such as energy consumption, waste management, and carbon in each of our operating regions. We have also developed region specific targets to ensure we are addressing local concerns, such as the development and registration of an Australian Reconciliation Action Plan, with further progress and meaningful reflection occurring constantly.

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June 16, 2021

PropertyEU – Logistics Watch: Cromwell expands in Europe with expert teams

Logistics and industrial assets currently account for around a quarter of the portfolio of Cromwell’s funds under management in Europe, although there are interesting geographical differences. While the asset class dominates the firm’s French and German portfolios, it represents an increasingly important part of Cromwell’s Italian and Nordic business as well. Logistics Watch talks to Andrew Stacey, Head of France, Pontus Flemme-Gardsell, Head of Nordics, and Lorenzo Caroleo, Head of Italy to find out more about territorial trends and how the runaway popularity of the logistics sector requires a systematic approach to acquiring and managing assets.

Read the interview in it’s full entirety here.

 

Property-EU-Logistics-Watch

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June 16, 2021

PropertyEU interview with Pertti Vanhanen, Managing Director Europe

PropertyEU Editor-in-Chief recently interviewed Pertti Vanhanen about Cromwell’s upcoming European initiatives along with his five strategic objectives to build upon Cromwell’s €3.7 billion AUM and increase profitability in the region.

The full interview can be found here.

 

Pertti-Vanhanen

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June 16, 2021

PERE: UK real estate freed from the ‘penalty box’

Investment activity was suppressed globally in 2020 as a result of COVID-19 with the UK real estate industry facing additional uncertainty surrounding Brexit. As vaccination continues to progress and Brexit arrangements finalise, the UK market is emerging again as a great opportunity for investment.

Cromwell’s Head of UK, Matthew Bird, recently participated in the PERE: UK Roundtable 2021. Matthew discussed the appeal of the UK market and particularly London to capital investors, the deep occupational demand for logistics and light industrial assets, along with the importance of tenant needs as the country emerges from COVID-19.

The full roundtable discussion can be read here.

 

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April 29, 2021

Inflation and its impact on real estate

Alex Dunn, Research Manager, Cromwell Property Group

Inflation is a key component of any economy. A change in the inflation rate is often seen as an early sign of impending change and the end of an economic cycle. A sudden spike in inflation can have a significant impact on investment portfolios particularly if investors fail to navigate it successfully.

A dangerous mix of closed businesses, higher unemployment rates and large injections of monetary stimulus from governments around the world, all as a result of COVID-19, has led to many experts predicting higher-than-normal rates of inflation are on the medium-term horizon.

In the US and across European economies, future inflation is forecast to be far higher than it was over the previous decade. In Australia, inflation is also expected to be relatively high, rising by 1.9% per year on average. High inflation would see interest rates rising, impact exchange rates and push highly indebted individuals, investors, businesses and governments closer to default.

The dominant concern of central banks at the moment, however, is still to try to raise inflation and inflation expectations hoping that this will be enough to raise interest rates above zero. This would provide room to manoeuvre in response to future negative economic shocks.

CPI-growth

CPI-by-country

How will inflation impact real estate?

Rising inflation can be both good and bad for real estate, and offer potential opportunities for investors. Real estate is often seen as a highly effective hedge against rising prices with assets that benefit from leases with fixed annual rental escalations effectively offsetting increases in inflation.

The downside for investors is that the typical response to inflation is to make money and the cost of borrowing more expensive. The fact inflation also devalues currencies forces most lenders to raise rates further, making the cost of debt even more expensive still for those that need it.

Positively for investors, inflation can lead to an increase in property values. For example, rising inflation will result in an increase in the cost of building materials for developments. Between the higher cost to borrow and the additional cost to build, new construction can become increasingly less attractive, especially as these higher costs tend to be passed onto occupiers. This can lead to a rise in the price of existing properties, particularly if the supply of new construction is reduced.

Inflation also typically leads to an increase in rental values with higher mortgage costs generally resulting in more people preferring to rent rather than to buy their own property. This increase in demand for rental properties and the influx of tenants usually prompts landlords to raise their rents.

 

Conclusion

The longer-term economic effects of COVID-19 will take time to fully emerge. While interest rates are extremely low, making it a good time to borrow, the huge and ongoing economic stimulus funded by governments around the world could drive an increase in inflation.

The benefits of the stimulus currently outweigh the potential future issues – but with debt levels at an all-time high, the balance between the two will be an increasingly fine one. Irrespective of the outcome the real estate sector’s ability to offset inflation through rental value growth makes it an attractive asset class relative to bonds or equities.