Sophisticated investors in non-asset specific vehicles also invested in warehouses, using them in the absence of current income from the development or redevelopment of other assets. Their focus tended to be on the income, rather than the value component of the asset. In the 90s, the introduction of REIT-type vehicles in various European countries saw the emergence of new, specialized investors who began investing in warehouses for their own merits.
The present situation
Warehouses are still a largely undiscovered asset class by most investors. Most particularly in Europe, there is still some ground to be covered until the investor landscape allows for a correct valuation of these assets. Most investors’ main focus is still on the current income return. Due to their limited experience in this segment, many often feel that there is a high risk of capital depreciation. There is a perception of obsolescence risk and a fear that re-letting a vacant building can be an exceptionally difficult task.
As with every asset class, warehouses have gone through a maturing process before being recognized as worthy for investment. Since the mid-90s, the product has found its standard, which is well-known to investors and other market participants. This standard has not changed significantly in the last 15 years, which is a sign of asset class maturity. This evolution of the asset class has been observed also in the US. Today, prospective tenants of warehouse properties have to choose between the following options:
- A fully automated warehouse, allowing taller buildings than the present standard.
The problem is that this type of building is not just a real estate investment, but involves equipment leasing as well. The facility is no longer a self-sustaining, reusable entity, but an appendix to machinery.
- A flexibly designed warehouse where most of the work is performed by the staff. The height limit for operating efficiently and safely with personnel-operated machinery is 12 to 14 meters. The emergence of this new type of building has led to the adjustment of fire regulations. There is strong evidence to suggest that most of these adjustments in regulations have been completed and the obsolescence threat due to changing fire regulations is fading away in most countries. In temperaturecontrolled warehouses, the need to comply with the increased sanitary requirements of the authorities is affecting older buildings, which may need heavy refurbishments. Once these are completed, it appears that a longer period of stability will be the case for refurbished or new buildings.
However, as this asset class is now maturing and in turn attracting specialized professionals (as has been shown in the brokerage community) the economics of warehouse investment are becoming better known. Like better-known products such as offices and retail properties, warehouse investment can also suffer from lack of flexibility and lack of diversification. Additionally, as with all real estate segments, the main driver of real estate value creation is location. Some of the factors to be considered are access to major highways, availability of rail service and relationship to major markets.
Flexibility can best be defined as the ability to respond to changing client needs. It is therefore important to track how the businesses in the buildings evolve. When touring the facilities, investors unfamiliar with this particular asset class can be amazed to discover the variety of businesses occupying them. The same goes for local authorities who may then regard the warehouses as something more of an asset than a local nuisance. The buildings have to offer the clients the space to run their business efficiently in the present, but also in the future as their business evolves
It has long been the dominant market practice to look primarily for single-tenant, long-lease buildings, without taking a valid portfolio approach. This strategy has produced appreciable short-term returns, but has also created assets difficult to re-let. For a well-balanced portfolio of assets that will deliver above-average returns, there are some simple rules to follow:
- It is important to have a valid diversification. The average value of each building is ideally between €15 and 25 mln; the minimum portfolio size of warehouse assets must be over €200 mln, which means 8 to 15 assets, which would also enable the employment of specialized asset/investment managers.
- Ideally, single-tenant assets should be limited to top locations. If the client cannot grow their business in the building, it will have to be re-let. Therefore, to minimize void periods, the building needs to be in an area of high demand, where clients have limited opportunities to find empty warehouses.
- Multi-tenant assets in quality locations, close to established manufacturing or distribution areas should be the backbone of any portfolio. They will probably need more active asset management, but the returns will follow, as good asset managers are emerging.
- Proximity to the end consumer will always be valuable. Up to now, the companies’ focus has been to concentrate on the competitiveness of their manufacturing process, but recently the focus has moved to optimizing the distribution cost.
The expected rewards
Every established asset class has its own challenges. In the developed economies, offices face a stagnating demand. Market dynamics is more oriented towards relocation than responding to new demand, which limits rental growth perspectives and implies increasing refurbishment costs. Retail has had a tremendous value growth in the last few decades but the impact of internet retailing on the ability of street retailers to pay rents is yet to be determined and it seems more and more likely that the boom years are over. Demand for warehouses is still benefitting from the transformation of the supply chain, the shift of part of the manufacturing base to countries with cheaper labor and the emergence of internet retail. Today, in some areas in the United States, capitalization rates for top warehouse assets are lower than the ones for offices; it is very likely that this will be seen in Europe too.
By Jean Van Hecke, Managing Director, Panattoni Europe
About Panattoni Europe
Jean Van Hecke is the Managing Director of Panattoni Europe. The company offers fullservice commercial real estate property solutions for clients in key European locations. Since entering Europe in 2004, Panattoni Europe has developed over 2.1 million m² of space. It is an affiliate of Panattoni Development Company, a leading US-based firm, who has completed more than 16 million m² of commercial
space since its inception.