The end of the warehouse bubble

At the property sector’s annual gathering on the French Riviera in March an unlikely group of delegates were centre stage: warehouse salesmen. In years past at the Cannes Mipim conference, purveyors of “sheds” — as they are known in the industry — have been shunted out to tents at the end of the promenade, away from the spotlight. But events over the past three years have changed that.

“On the back of Covid . . . investors who were awash with cash all put logistics [properties] at the top of their shopping list. You would go into any meeting and investors just wanted to buy sheds,” says Marcus de Mincwitz, head of industrial and logistics property for Europe at Savills estate agents.

In the early months of 2020, his team flew drones around vast empty warehouses in the UK to provide virtual tours to investors. Cash poured into sheds all over Europe — much of it diverted away from areas of the property sector that were proving vulnerable to Covid lockdowns, such as offices and shops. A boom in ecommerce during the pandemic only increased demand for warehouse space.

As this flood of money washed into a relatively small corner of the real estate market “prices went up”, de Mincwitz says, “and they went up so quickly . . . the second half of 2021 was astonishing. Everyone was pushed to the limit.”

Yet the sector now faces a growing list of concerns that threatens to reverse that rush of interest. The ecommerce boom is showing signs of slowing, the global economy is cooling and pushback from local opposition groups to massive warehouse complexes is growing more vociferous in some parts of Europe.

These factors are clouds on the horizon, but the storm immediately overhead is rapidly rising interest rates. The Bank of England has already raised rates multiple times since the start of the year, culminating this week with the biggest increase in nearly 30 years. Last month the European Central Bank announced it would follow suit with its first rate rise in more than a decade as inflation surges, energy supply concerns mount and political turmoil builds across the continent.

If European economies tip into recession — as economists have warned is “increasingly likely” — a wave of business failures could leave warehouse owners saddled with acres of empty space. In May, a stark warning about the potential impact of an economic slowdown on the sector came as ecommerce giant Amazon warned its growth rate would ease and shares in listed warehouse owners tumbled.

Investors also face challenges — especially those who stretched themselves to buy into the sector at the top of the market and who may struggle when they come to refinance their loans on harsher terms.

“My entire career has been [spent] in a lower-interest-rate environment, and I started in 2006,” says Louis-Simon Ferland, founder of Boreal IM, an investment manager that is assembling a €3bn pan-European logistics portfolio in partnership with Canadian real estate investor Cadillac Fairview. “We have all [become] used to it and now we’re going to a new environment, it’s undeniable.”

Froth in the market

The apparent unwinding of a prolonged era of cheap money has changed the outlook for investors. Their basic calculus is simple: to make a given project worthwhile, a new purchase can be signed off as long as the costs — chiefly construction, upkeep and repayments of debt — are outweighed by the potential rental income.

Rental income relative to the value of the property (known as rental yield and expressed as a percentage) is a key metric for commercial property investors. Broadly speaking, if the yields on a property are higher than the all-in borrowing costs, they can expect to make money.

While borrowing costs were extremely low, investors were buying sheds with rental yields of less than 3 per cent. But as rates have risen, the margin between interest payments and yields has narrowed (and in some cases entirely disappeared), forcing investors to revise their calculations.

Rate rises have cooled investment across all commercial real estate sectors, but the inertia for warehouse investors is particularly great. “The all-in debt cost has doubled, so paying 3 per cent for a shed just doesn’t work. Logistics was right at the front of this [rising interest rate] storm because yields had gotten so slow,” says de Mincwitz.

Inflation in the cost of labour and building materials is becoming another burden for developer-investors, pushing the expense of erecting and maintaining a shed up considerably. The price of some materials has increased 20 per cent or more, according to a number of agents, investors and developers. Ultimately, they believe that prices will have to come down to meet the new economic conditions, but for now, they say, there is stasis while buyers and sellers recalibrate.

“Everything freezes and deals stop over the summer [but] when we come back in September, I think we will see repricing,” says Nick Preston, chief executive of Tritax Eurobox, an investor and operator of large logistics warehouses in Europe.

A number of UK assets, whether individual sheds or portfolios of properties, have been pulled from the market, with sellers unable to shift them at the desired price. The largest portfolio to be withdrawn in recent weeks consisted of 16 warehouses spread around England, which private equity firm KKR and logistics investor Mirastar had been hoping to sell for more than £800mn, according to React News.

“A lot of froth has been taken out of the market and a few large transactions . . . have not gone through,” says Ferland.

He says the UK’s more developed warehouse market has adjusted quicker than its European counterparts, with deals being negotiated at prices 10-20 per cent below their peak earlier in the year — a drop that might push through some deals. On the continent, the correction had only been 5-10 per cent, he adds, with sellers struggling to adapt to the new economic environment.

“Everyone is willing the market to go through a very, very quick correction. You talk to the private equity houses and institutional investors, [they are] hoping that vendors wake up and realise that the market has changed and changed for the long term,” says de Mincwitz.

Cold shower

The shed market’s rampant growth over the past decade has been underpinned by the ecommerce boom, with online retailers requiring more storage space than their high-street competitors. Every additional £1bn spent online translates into demand for 1mn square feet of warehouse space, according to estate agency CBRE.

The market is broadly split into two: mammoth, out-of-town sheds, known as “big boxes”, and smaller, urban sites dedicated to last-mile delivery. Over the past decade, vacancy rates across both types of asset in Europe have consistently fallen. As well as the growth in online retail, warehouse demand has been supported by the expansion of grocers and third-party logistics firms such as DHL and FedEx, as well as the arrival of new tenants such as movie studios. Higher demand for new space gave landlords more freedom to raise rents.

Investment in the sector steadily increased and red-hot demand brought a windfall for the biggest landlords. Segro, which owns warehouses and data centres mostly in the UK, has been one big winner. In the decade to the end of last year, the company’s share price increased seven-fold.

Private investors have been an increasingly active presence. Since describing warehouses as its “highest conviction” sector in 2019, private equity fund Blackstone has built a €21bn European platform and was the biggest spender in the European warehouse market over the past 12 months.

That growth was turbocharged by the pandemic, but there are signs that it might now be falling back. In April, Amazon issued a profit warning that wiped billions from the value of listed warehouse owners around the world. It is difficult to overstate Amazon’s influence over the sector — both as a customer for space and a barometer for online retail sentiment. The company accounted for one-quarter of all new space leased in 2020 and 2021 in the UK and has an even more established presence in the US.

In the fortnight following Amazon’s warning, UK-focused companies Tritax Big Box and Segro lost 20 per cent of their market capitalisation; US-focused Prologis lost about 30 per cent. None of the three has recovered those losses in the months since.

European investors and analysts play down the impact of Amazon’s statement in Europe, claiming the company is only retrenching in the US and that still has room to expand on the continent. “The Amazon warning was a cold shower for the sector, but it has to be seen in context. The growth in the US during the pandemic was humongous [and] in this business the wind blows west to east,” says Ferland.

Few expect the pandemic’s breakneck rate of ecommerce growth to continue. In the UK, the proportion of total retail sales booked online almost doubled between February 2020 and January 2021, peaking at 38 per cent, but has since dropped back to 25 per cent, according to official data. One-quarter of the new leases signed last year by the US’s Prologis, the largest warehouse owner in the world, were to ecommerce businesses. In the first half of this year, it was 14 per cent. Prologis now anticipates a small increase in the vacancy rate in US warehouses next year — an ominous sign if the industry winds do blow from west to east.

De Mincwitz estimates that 65 per cent of the logistics market is in some way linked to retail, a sector that would be at the sharp end of a consumer-led downturn. “We’re in the market and we still believe in the trend but obviously everything has changed,” says Ferland. “There is part of…