The logistics sector has boomed in recent years, no more so than during the pandemic which has fast-tracked the shift from “bricks to clicks”. Real Estate partners David Roberts and Kathryn West have been advising investor and developer clients (such as LondonMetric, Oxenwood and Urban Logistics) on logistics transactions for many years. In this Q&A piece David and Kathryn share their top tips on successfully completing major logistics deals and the traps to watch out for.
Q: Why do you think the logistics sector has had such a good time of it in recent years?
A: Retail was already in a dark place courtesy of the internet and a struggling High Street. The tide was turning anyway but Covid has accelerated the move away from bricks and mortar. As one commentator put it, we have seen how quickly “distressed becomes destroyed”. There has been a three year pivot towards on-line sales in the last few months. Pre-Covid, on-line spend was circa 20% with a horizon for 30%, but this is now forecast at 40%. During lockdown there have been a number of “first time adopters” who will simply not return to shops as regularly e.g. online food sales have moved from 7% to 15%. In the current economic climate, shareholders are demanding diversification to protect their investments and maintain yields. Logistics is the latest “hot” sector in the alternative capital market (following PRS, Student Accommodation and Assisted Living).
Q: What are the current trends in the logistics sector?
A: As the logistics sector has become more sophisticated and user demand has grown, there is an increase in demand for automated equipment and robotics to speed up the delivery process and reduce workforce levels and costs. Workforce currently represents circa 40% of the operating cost of a logistics site and there is a shortage of skilled workforce such as fork lift truck operators and HGV drivers, particularly in the South East. Pioneers in the sector are aiming for fully automated racking and robotics.
A consequence of automation is the demand for larger unit capacity. Occupiers are now looking for bigger floor areas and higher ceilings to accommodate modern digital racking systems and an increased volume of product.
Environmental and sustainability criteria are high on the agenda of all industry stakeholders. Automated equipment and electric supply vehicles require a large electrical capacity to the units so planning conditions linked to sustainable energy sources can be expected. Extra power supply is expensive and difficult to secure so a good pre-existing power supply is essential to future proof increasingly automated sites with large numbers of electric vehicle charging points.
The current “holy grail” of the logistics world is last mile logistics centres. These are buildings where the HGV from a large logistics centre unloads its cargo and it is reloaded into the delivery van which appears at your front door. Consumers pay a premium as they choose “next day” or “same day” delivery options, which is increasing the demand for last mile sites. Land for these locally based sites is scarce and competition is high especially from alternative uses such as residential. If secured, the site will attract a prime yield and the scarcity will protect the investment value and ERV.
Q: What are the current challenges for the logistics sector?
A: There are a number of key challenges for the sector as consumer demand for on-line shopping grows and technology evolves.
Almost all industry stakeholders now have concerns about sustainability and green benchmarks. For logistics units, power supply and vehicle movements are key areas where sustainability improvements can be made. We often see planning conditions requiring a certain percentage or quota of energy used by the unit to be sustainable at source. Solar panels on the roof of the unit are a common solution and where there is wider land availability, wind turbines. However solar panels can also create challenges with construction packages. Large amounts of heavy solar panelling on a roof can require extra loading support and loading the roof in this way may also invalidate the existing warranty protection for the roof.
Linked to power supply, sustainability and future proofing are issues with density. For example, we recently advised on a site where moving from traditional petrol/diesel vans for local deliveries to electric vehicles (the stated ambition of many of the key players in a very short time frame) would reduce potential vehicle movements by 90% a day with the existing power supply levels and site configuration. This reduction would have a huge impact on the long term capital value of the site and the likelihood of lease renewal if left unresolved as distributors move to electric vehicles.
The demand for larger, sustainable units is pushing engineering norms and it is no longer simply “location, location, location” – it now involves vocation. A well enabled workplace with socially distanced work spaces.
Q: You have both advised on many logistics transactions. On the legal side, what are the latest trends?
A: Over the years we have advised on traditional portfolio transactions for investor landlords. At the moment sale and leaseback models are popular with occupiers and major players in the distribution sector looking to separate their operating businesses from their real estate assets.
In terms of investment there are two distinct approaches in the sector (i) secure long term lettings where “Income is King” e.g. 15 year lettings to the likes of Amazon, Primark and Next where WAULT of 10 plus years (Weighted Average Unexpired Lease Term) drives the share price and (ii) short term leases of circa 5 years to match the underlying distribution contracts e.g. DHL and NHS Direct where the income is less secure (no guaranteed renewal if the underlying contract vanishes) but big capital gains on a re-gear.
With increasing demand for space during the Covid pandemic, the logistics sector has become more of a landlord market. We are starting to see upward only open market rent reviews rather than indexed linked reviews which were commonplace in the sector.
The world of logistics is dominated by a small number of key players who have their own bespoke requirements which have become “institutionally acceptable” terms in the sector. Examples include alienation clauses which permit sharing with business suppliers as well as the usual group company concession, pre-authorised consent to assignment to the underlying customer and reduced landlord controls over alterations to the unit.
Clean planning permissions permitting 24/7 operation are essential for both investor and occupier to provide the desired unit functionality and maintain investment value.
Q: Where do you see the future of the logistics sector?
Logistics is now viewed as a prime asset class in its own right. Industrial and distribution was once seen as the “poor man’s sector” but this is definitely no longer the case, with land values and yields remaining strong and even growing in recent years. Logistics is a “hot” area for institutional investors looking to diversify their portfolios as other areas which have traditionally dominated decline. The shift to on-line looks likely to continue so the sector will continue to capitalise on this trend.
Employment, construction and planning issues, power and density challenges are probably with us for a while but investment in the latest robotics and automated equipment by key market players will speed up processes and efficiencies. We expect to see more developments in this area continuing the trend for larger units. In summary logistics units will be bigger, better and in demand!
Key points
- Location is as critical for logistics units as it is for retail – but different factors are at play
- Lease lengths are likely to reflect underlying supply contracts, which also feeds into alienation covenants
- Be careful that the push towards environmentally friendly ways of operating doesn’t means that tenant fit out works invalidate your warranties