UK offers higher returns

For almost a decade now, the UK logistics sector has been undergoing a fundamental, structural change, driven by the insatiable appetite of the UK consumer for goods to be delivered to a place of their choosing.

While this has brought the retail market to its knees, the writing has been on the wall for some time: internet penetration of retail has increased steadily from 2.5% in 2006 to 20% in December of last year, according to ONS statistics, and shows no sign of stopping.

This, combined with investors’ global hunt for yield, has made logistics one of the most sought-after sectors in the UK today. UK industrial yields now sit below retail yields for the first time ever, according to MSCI.

Cynics will look at these trends and suggest that yields will revert to their long-term norms, the market is overheated and yields cannot go any lower without facing serious challenges if interest rates start to increase. Yet at AEW, we do not see the trend of a growing global, multi-channel retail market reversing any time soon.

Expected returns and what is considered “expensive” are, as always, relative positions. If there is a long-dated, inflation-linked income stream that meets a domestic investor’s liabilities on a grade A asset with a good covenant in place, this is deemed very attractive to some, irrespective of what happens to the value over time.

But international investors are also attracted to the structural changes in the UK logistics market. In many cases, they see UK internet retail penetration levels far exceeding those of our European and global counterparts, but require slightly higher returns to compensate for the additional risk of moving overseas, dealing with currency and of course Brexit risk.

Yet Brexit may also throw up opportunities. For example, not being in a European customs union could be positive for UK port cities, as goods from China, the US and elsewhere would be unlikely to go via European ports to avoid import duties.

Our own market research suggests that the UK, in relative terms, offers better value than the Continent, with relatively attractive yields and forecast returns over the next five years. On a five-year annualised basis, we are forecasting 5% total returns for prime let UK logistics, driven predominantly by income returns. The initial yield on prime logistics should be at a market average of 4.6% by the end of 2023.

For international investors who require greater returns, we see attractive long-term returns through a “build to core” strategy where investors can gain up to a 200bps premium over a stabilised asset’s investment yield. There is significant occupier demand for logistics space and we do not see this subsiding in the near term.

Nick Winsley is head of investments at AEW UK Investment Management