Although the sector won’t be immune to a recession, the occupational market and long-term opportunities remain strong. That said, it will be critical to focus on asset quality and the fundamentals that are driving performance.

Some stability has started to emerge in 2023 and we are already seeing signs of investor interest returning in the UK and the Netherlands. Successful capital raisings have also provided evidence of longer-term conviction in the sector.

Will warehouses keep on trucking?

Supply chains were hugely disrupted by the Covid-19 pandemic, which reinforced the value of well-functioning logistics systems. Dare we forget the 2020 toilet roll crisis? But structural drivers have been in play for some time now and we have been recommending an overweight position in logistics real estate for many years. The changing fundamentals started nearly a decade ago, with the emergence of three key trends: de-globalisation, the birth of large-scale ecommerce, and the need for modern and energy-efficient supply chains.

Firstly, protectionist policies introduced in the US and the UK show that de-globalisation has been in train for some time. Covid-19 further accelerated various aspects of this mega trend, resulting in the stress-testing of existing supply chains and more onshoring. Recently, we've seen more energy interdependency and a trend towards domestic production of car batteries, with manufacturing plants springing up in places like Norway, Sweden, Canada, and the US. But why does this matter for investors in logistics property? Well, the trend has shortened supply chains, which has led to new warehouse locations and more logistics assets being developed near end-users.

Secondly, ecommerce remains an incremental demand driver for the long term, despite a slowdown in recent growth. A slowdown was natural after the pandemic-related ecommerce-boom, when online sales were artificially boosted by lockdowns. While much of this is related to the rise of Amazon, existing bricks-and-mortar retailers have also invested in supply chains to capture more online sales and to compete with Amazon. Launching online platforms might increase sales, but existing warehouse infrastructure is not suitable for this type of demand-driven distribution. Indeed, it has been proven to be unprofitable without necessary reconfiguration. Investment in new locations and modern warehousing is essential – particularly when it comes to handling returns, which can be as much as 60% of sales in the case of ‘fast fashion’, for example.

Thirdly, environmental, social and governance (ESG) factors and carbon net-zero targets are becoming more important for both tenants and investors. Tighter regulations – such as the EU’s new Energy Performance of Buildings Directive – and more stringent valuation guidance from the Royal Institution of Chartered Surveyors, are encouraging investors to upgrade stock to improve efficiency. For tenants, soaring fuel bills are pushing them towards better-located and higher-quality buildings. The appeal of photovoltaic cells on a roof, for example, can potentially turn a cost into a positive revenue stream. The need to modernise warehousing will further widen the gap between future-fit assets and those facing obsolescence. In short, ESG considerations are now central to logistics real estate and commercial real estate more broadly.

Do the fundamentals reflect the theory?

Overall logistics leasing demand remains strong. Take-up across the 13 largest logistics markets was 23% above the five-year average in 2022. Germany, Poland, France, the Netherlands, and the UK had the lion’s share of take-up at 78% of all leasing activity. The flight-to-quality theme continues to be key, with the vast majority of take-up in new warehouses.¹

Despite some pockets of increased development, such as in the UK, we expect the supply side to remain constrained in 2023 and 2024. The average European logistics vacancy rate fell by 1 percentage point to 2.9% in 2022, a record low level. In many markets, the supply of high-quality space is negligible and most leasing activity is decided during the pre-let or construction phases.²

These pressures in the market have led to strong rental growth. UK industrial rents have increased much more quickly than in Europe. This is mainly due to intense demand and supply pressures around major cities, a lack of suitable sites, and the maturity of the UK market from an ecommerce perspective. In Europe, rents have only experienced strong growth over the last two years as the same demand and supply imbalances have taken longer to build. The pace of rental growth is likely to ease-off as market forces begin to normalise. But we think the supply chain reconfiguration taking place is a 10-year transition, and unlikely to be resolved in this real estate cycle.

Will logistics be the comeback kid in 2023?

Logistics real estate is well positioned to navigate the current high inflationary environment, thanks to rental growth, robust market fundamentals, and indexation in European leases. Backed by record-low vacancy rates and structural demand drivers, rental growth is expected to retain positive momentum in most UK and European logistics hotspots. Logistics space in good locations remains undersupplied, which means cashflows should be resilient and strong, with income growth persisting in the long term.

While lingering economic, political, and financial market uncertainties may disrupt investment trends in the short term, the ongoing ecommerce boom, onshoring, supply chain reconfiguration and modernisation should remain important drivers for logistics. However, going forward, as the outlook for logistics real estate improves, helped by important structural forces, we believe it will be more important than ever to focus on asset quality.