Long before the Covid-19 pandemic struck, institutional investment in Asia’s burgeoning industrial and logistics property sector was increasing sharply. In 2018, transaction volumes surged to just over US$13 billion, nearly double the level in 2017, according to real estate consultant RCA, as the rapid growth in e-commerce fueled demand for warehouse space.
The pandemic has proved a boon for the sector, accentuating the key drivers of the market – long-term demographic, economic and technological forces that are changing the way people live, work and shop – and turbocharging the adoption of e-commerce.
Among the main sectors in commercial real estate, logistics is the only one to have emerged from the crisis in a stronger position. In the first quarter of this year, logistics transactions in the Asia-Pacific region rose 26 per cent year on year, and accounted for 23 per cent of all commercial property deals, data from JLL shows.
While this is only half the share of office investments, which account for the bulk of the market in Asia, it is double the proportion five years ago. Indeed, from a sentiment standpoint, logistics is far and away the most popular type of commercial real estate.
The fierce appetite for Asian warehouses was evident in the findings of a survey published in January by the Asian Association for Investors in Non-Listed Real Estate Vehicles. Among the city-sector investment combinations most favoured by respondents, the industrial and logistics sector accounted for six of the top 10, with warehouses in Sydney and Melbourne ranked first and second respectively.
Not surprisingly, the weight of capital targeting Asian logistics and the extreme bullishness around the sector have driven up prices to levels that look increasingly stretched for an asset class that is significantly less liquid and suffers from a lack of institutional-grade stock that makes it difficult for investors to build scale.
In a foretaste of things to come in the region, rental yields on premium logistics assets in Sydney are now on a par with their office equivalents, having fallen by more than two percentage points since the beginning of 2016. In Seoul and Shanghai, the gap between logistics and office yields has narrowed to just one percentage point, data from JLL shows.
At a time when there are mounting concerns about liquidity-fueled bubbles in capital markets, it is not surprising that the fierceness of the decline in yields is fanning speculation that Asian logistics is a bubble in the making.
Yet, while the yield compression, if sustained, increases the risk that the sector becomes overvalued – and there are reasons to be skeptical about unbridled optimism about any asset or industry – the tumbling yields on Asian logistics properties are defensible.
First, there is a lot less uncertainty about the prospects for logistics real estate than there is about the future of offices. While the virus-induced mass work-from-home experiment poses a significant challenge to the role and purpose of offices, the pandemic has proved hugely beneficial to both the fundamentals of logistics properties and, just as importantly, investors’ perception of the sector.
Just a cursory glance at leasing activity shows the extent to which the virus has proved beneficial for logistics assets. Net absorption of warehouse space in major markets in Asia was not only higher last year than in 2019, demand in the first quarter of this year was the strongest for a first quarter in at least a decade, data from CBRE shows.
Moreover, many of the forces that are underpinning demand will outlast the pandemic. Not only is Covid-19 helping to raise the long-term growth rate of logistics real estate by increasing the role of e-commerce as a key driver of demand, it is also having a profound impact on supply chain management, creating new standards and benchmarks that will speed up the development of modern logistics facilities.
Second, if there is a bubble in the making, it is not in Asia, but in the United States, where yields on premium logistics assets in many cities, notably New York and Philadelphia, have fallen below those on offices. While logistics yields in Asia have declined more sharply than in other sectors over the past few years, they are dropping at a slower pace than in Europe and the US.
Third, although office buildings are much easier to acquire and more actively traded, the resilience and defensive characteristics of logistics properties have become much more apparent since the pandemic erupted. As high-quality warehouses become critical to many companies’ operations, investors are bound to want to increase their exposure to the sector.
With benchmark government bond yields set to remain at ultra-low levels for at least the next two years, higher-yielding property holds increasing appeal. JLL believes logistics “will become a core part of Asia-Pacific institutional real estate portfolios over the next five years”, partly because of its “diversification benefits”.
This will inevitably heighten concerns about valuations. Yet, with such enviably strong fundamentals, and a compelling narrative in a post-pandemic world, logistics is likely to remain one of the safest bets in Asian real estate.