German logistics is hot. Occupational activity has been record-breaking as rising ecommerce penetration and the shift towards supply chain resiliency has supported demand. According to our calculations an additional two million sqm of logistics space alone will be needed in Germany over the next five years to accommodate ongoing growth. Given land supply is highly constrained, this bodes well for future rental growth prospects.

Reflecting this, investors are acquisitive. Last year some €28bn was sunk into European logistics according to RCA. German logistics/ light industrial transaction volumes in 2021 equated to €9.2bn according to Colliers or €10bn according to CBRE. With so much capital chasing such limited stock, yields are under pressure. Over the last year prime logistics yields have compressed by 40 basis points to reach 3.0% in Q4 2021 according to CBRE, and if their forecasts prove correct further moderate sharpening is likely.

This leaves many investors pondering how they can benefit from the sectors growth prospects without compromising on well-priced entry yields. In our view, informed investors have two routes in particular to secure more value: increase the light industrial allocations or gain pan-European diversification.

Light industrial shift

Light industrial stock comprises space used for manufacturing, production activities such as part assembly and repackaging or research and development. Typically light industrial has higher office content than logistics stock and may comprise smaller assets or multi-let tenancies. Like logistics it benefits from exposure to cyclical economic and structural growth in online retail and supply chain recalibration but at more compelling entry prices.

Light industrial accounts for a large proportion of German industrial and logistics supply. Much of this is situated in urban areas where land competition is intensifying due to urbanisation. This underpins land value and offers future upside potential from densification for either co-located light industrial/logistics with other mixed-uses, or potential conversion to other uses entirely such as residential. This has the potential to deliver better performance.

Unlike logistics though, light industrial stock is far more differentiated and bespoke to the occupier and purpose. To acquire stock with resilient income and growth potential, investors must apply a granular approach to stock selection. Although granularity is needed, the right specialist can still build scale quickly, comparable to a logistics portfolio. Partnering with investment managers who understand local markets, are well connected to occupiers and can make informed decisions is vital.

Logistics Pan-European diversification

Another option for distribution-seeking investors is to expand into other higher-yielding European markets. Prime logistics yields of 4.25% in the Czech Republic, 4.35% in Poland and 3.95% in Italy are clearly appealing relative to Germany (figure 1). Occupier demand for quality stock in these markets is rising and land supply in the top locations is tight.

Not only will pan-European diversification bolster distributions, but it also spreads income risk by gaining exposure to assets and occupiers subject to different country dynamics. This reflects both the unique economic prospects of each European country and, of particular relevance to logistics performance, differing stages of online retail market maturity.

Countries with ecommerce penetration of below 10% of total retail spending are immature. Analysis from mature markets such as the UK and Netherlands demonstrates when penetration rises above 10%, logistics occupier demand also accelerates. The demand impetus typically proceeds faster than the supply response, especially given it is increasingly hard to find sites and gain permission for new logistics development, leading to rapidly escalating rents. Rental growth tends to endure when markets reach maturity above 18% penetration as occupiers seek to consolidate their distribution networks to maintain market share.

Many European countries have recently entered the maturing stage of ecommerce growth (figure 2). In addition to Germany (16% online penetration in 2022 according to CBRE) these include the large Italian (10%) and Central and Eastern Europe economies (14% and 17% in Poland and Czech Republic respectively). This bodes well for future rental growth prospects in these countries and those who invest there.

Wise pan-European diversification requires a robust understanding of local market dynamics. Whilst logistics stock is fairly generic, local country particularities have a significant impact on return prospects and requires granular market expertise in order to make informed decisions.

Broader allocation will deliver income

In summary, we expect that compelling long-term fundamentals in the logistics sector coupled with low distribution yields in core logistics will prompt a growing number of investors to diversify. Diversification will encompass acquiring higher-yielding light industrial stock in Germany which benefits from exposure to similar occupational drivers and often has underlying land value. It will include European diversification to gain exposure to stock likely to benefit from rapidly escalating occupier demand at more compelling yields. Such diversification also spreads risk and smooths income returns.

Effectively executing a diversification strategy of this nature requires partnering with an informed investment manager with a true pan-European presence. This is a sophisticated approach which relies upon detailed knowledge of evolving occupier demand and how that relates to real estate. Local markets must be thoroughly understood in order to understand their unique characteristics and identify the most attractive investment opportunities. Local relationships with landlords and occupiers will also help to maximise performance potential.