Urban logistics is among the high-growth sectors that have borne the brunt of repricing, but for LondonMetric chief Andrew Jones, it will continue to be real estate’s best-performing asset class.
That conviction has been illustrated by the REIT’s sale of a 142,000 sq ft DHL warehouse in Solihull for £20.5m to a pension fund, reflecting a 4.2% net initial yield and a 2% premium to book value. It has crystallised an ungeared 9% IRR, having previously been acquired in 2017 as part of a portfolio bought for £15.7m.
For Jones, the deal demonstrates the enduring strength of logistics as an asset class. Although the market has been hit, LondonMetric’s conviction in the sector remains “undiminished”, particularly in urban locations.
Despite a £600m loss in portfolio value, which fell to £3bn in the year ending 31 March, trading has stayed solid, with rental income growing by 10.3% to £146.8m. The owner’s logistics properties posted 11% ERV growth during the period, with rent reviews settling 16% above previous passing rents on a five-yearly equivalent basis.
“Investors will focus on sectors where they are getting a reliable, repetitive and growing income stream,” Jones told EG. “We are seeing that in the warehouse market clearer than we are in any other sector in real estate, which is why pricing and liquidity has returned fastest to this particular sector.”
Big grocery is out
LondonMetric’s investment activity will continue to remain focused on urban logistics, convenience retail properties and retail parks.
“History teaches us that periods of uncertainty always pass, and eventually inflation will be tamed and interest rates will stabilise,” he said. “What is even clearer is that the strong occupational fundamentals supporting our chosen sectors remain intact. Broadening occupational demand and constrained supply are creating ideal conditions for continued rental growth, particularly for our urban warehouses, which remain our strongest conviction call.”
By contrast, Jones said the “best days” for larger supermarket stores appear to be over, after “years of rental compounding”. He noted that shortening leases will “expose” their values in the same manner as department stores when they were “exposed to true market fundamentals”.
“Big grocery has had huge competition from the internet and from smaller-format operators over the past 10 or 15 years,” he said. He pointed out that the dominance of the “big four” – Tesco, Sainsbury’s, Asda and Morrisons – has waned as discount retailers and players such as M&S and Waitrose have gained an increasing market share. “There are an awful lot of people in the market at the moment – as a result it makes it harder for the big four to strut their stuff as successfully as they did.”
In addition, offices are facing a reckoning similar to that of retail in recent years. Jones noted that outside of the West End, the office market is “starting to attract similar comments to those that were being made about shopping centres seven or eight years ago”, as workers continue to shun the office after the pandemic and occupiers reduce their physical footprints. At the same time, the need for offices to meet new sustainability standards has led to an increasing unwillingness to lend on certain older offices.
As such, Jones warns of “a refinancing tsunami coming”. “The smart money is predicting that, as well as ‘owning’ a number of shopping centres in the UK, the lending banks will increasingly be the ‘owners’ of regional offices,” he said.
Clarity needed on swap rates
While there is no shortage of market commentators calling the bottom of the market in recent weeks, Jones steered clear of making any such prediction, citing the ongoing lack of clarity on swap rates. “My crystal ball is a bit cloudier than those of some people who are obviously a lot smarter than me,” he said.
“My view is that until the five-year swap falls down to 3%, or even lower, it is difficult for us to have any strong conviction that liquidity is going to return to normality in the real estate sector.”
In the meantime, Jones said investors should stay cognisant of ongoing turmoil in the US real estate market. He noted that while it has a different banking structure to that of the UK – dampening fears of a similar situation occurring domestically – it would be “naive to ignore” the issues it is experiencing.
“What you see in the US around the office market is particularly worrying,” said Jones, highlighting that “some similarities” exist with other European locations. “Office occupancy will be challenging for some people.”
Detaching from divestments
In the meantime, LondonMetric’s move to buy CT Property Trust has underscored the opportunistic plays that market conditions are facilitating at the moment.
The £198.6m CTPT takeover will create a combined group with some £3.3bn of properties, 71.5% of which consist of distribution and industrial facilities.
With CTPT trading at a circa 34% discount to NTA, the proposed deal is an opportunistic play for LondonMetric, and a “sensible way” to access assets at a “reasonable price”.
The main draw was its warehouses, which account for 56% of CTPT’s portfolio. If the deal proceeds, assets that are likely to be up for disposal include offices, which amount to 15.7% of its portfolio.
“We are not emotionally attached to any of our assets,” added Jones. He pointed out that the business has so far monetised around 30% of the A&J Mucklow business, which it bought in 2019. “Save your emotion for your family and your friends, rather than for your assets.”
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See also: LondonMetric’s Jones on befriending market uncertainty
