Consolidation is a sign of an industrial market that is maturing
The European logistics real estate industry is increasingly being dominated by a number of well-capitalised companies. Those few, if they have grown smartly and own high-quality facilities, are far better able to accommodate and meet the needs of customers and investors.
This consolidation has come about in anticipation of the rare combination of rental growth and yield compression, coupled with greater availability of funding, driven by sustained occupier and investor demand, lack of supply and declining concessions.
I believe the breakthrough moment for our industry was the completion early last year of Prologis European Logistics Partners, our £1.9bn joint venture with Norges Bank Investment Management. This new venture was perceived as a watershed event that signalled the logistics real estate market had thawed after the long winter of the global financial crisis.
Since then, investor appetite for industrial and logistics properties has increased significantly. Last year, the volume of industrial property investment transactions in Europe topped £10.2bn excluding the Norges/Prologis joint venture, according to figures from CBRE, making it the highest year since 2007. That momentum has continued into 2014: total industrial investment activity in the first half of this year was around £6.7bn, which was the highest total since the second half of 2007, according to CBRE.
The surge in investment transactions has led to cap rate compression for five consecutive quarters. Industrial values remain very attractive by historic standards and have just started their recovery - Prologis estimates put them at around 22% below their level at the last peak in 2007. Market data shows that asset values are up 6% year on year, but the transaction markets are moving even faster. Comparing the turning points in the cycle, we believe Europe is two years behind the US, which makes Europe a very good value proposition.
The largest logistics property owners with their pan-European platforms and their experienced teams tend to own the best logistics facilities and dominate current transaction activity. The scarcity of good stock on the market in most locations and competitive bidding when assets become available make it so difficult for smaller investors to buy assets that they are increasingly selling their assets to the big players.
The development sector is also dominated by a small number of companies. The five largest developers combined accounted for around 43% of development activity in the second quarter of this year. There were 55 development starts in those three months totalling around 11.8 million sq ft, according to Prologis estimates. Although development is on the rise, supply is muted and years away from being a notable risk factor. As opposed to demand, supply has declined since 2008 with a clear focus on build-to-suit. Speculative development starts are increasing, but remain significantly below the level of about 60% in 2006 to 2007.
Demand, on the other hand, has remained strong in spite of the weak economic climate, confirming that structural drivers, particularly supply chain reconfiguration, are key. Today, class-A product in Europe is approximately one third of that in the US. Many customers in Europe occupy older and smaller buildings and are looking to reconfigure their supply chains to make them more efficient, both from a cost and service perspective. Take-up levels in the past three years are in line with the volumes recorded in 2006 to 2008. The growth of ecommerce is also having a very positive effect on logistics providers, leading to net new demand for facilities across Europe.
This supply/demand imbalance is causing rents to rise. Rents dropped by approximately 20% on a net effective basis from the peak of the previous cycle to the trough of this one, bottoming out during the second half of 2011. Since then, trough rents have rebounded by 7.8% in Europe, but they are still about 12% below a level that warrants new construction. Rent growth slowed overall in Europe during the second quarter, with positive figures in the UK and northern Europe offset by negative figures elsewhere, but this is part of the ebb and flow of the market.
Such market conditions are making logistics one of the most sought-after real estate classes and, I believe, consolidation will continue. In logistics real estate, scale is vital. Those with a true global platform have a significant advantage because they can offer customers variety, consistency and reliability. To succeed in logistics real estate, you must be where your customers want to go, as the customers really are king.
Philip Dunne is president, Prologis Europe