?Europe is lagging in terms of quality logistics assets, presenting opportunities to fund development transactions.
?Existing stock could face increased competition in the low interest rate environment.
Gramercy Europe has been steadily acquiring European logistics assets in its flagship real estate investment fund, most recently purchasing a 60,500-square-meter warehouse in January in Utrecht in the Netherlands. The investment fund manager, a subsidiary of U.S. REIT Gramercy Property Trust Inc., focuses on single-tenant and sale-leaseback transactions. CEO Alistair Calvert explained to S&P Global Market Intelligence why they have focused much of their roughly €1 billion fund on industrial real estate.
What follows is an edited transcript of that conversation.
S&P Global Market Intelligence: Tell us about your recent logistics acquisition in Utrecht.
Alistair Calvert: We’re focused on high-quality, single-tenant, net lease logistics assets, and this ticks all the boxes. The lease length was a little shorter than we would normally be interested in, but it's still quite long for the logistics world. We were comfortable with it for various reasons. One was that Kuehne + Nagel is very dedicated to that asset, and this can be seen by the fact that it has located its senior management team and central office function there.
Another aspect that would normally be a negative for us is that there is an automated high rack system in place, but in this instance it was probably a neutral or even slightly positive factor. As a general rule we don't like these, because they tend to be very tenant-specific, capital-intensive, they make a building difficult to re-lease, and they are expensive to maintain. However, the tenant paid for the fit-out of it, and it's a Euro-pallet system, which is highly flexible and can be used for a high range of products.
Kuehne + Nagel is one of the few leading 3PLs [third-party logistics companies] that we didn't already have as a tenant. And finally, we're sold on the location; it's an infill location, and there's very little land left in the greater area.
What are your thoughts on additional occupier investments into building fit-outs?
When you look right across our portfolio, I would say that there's been a very high level of investment by tenants for the majority of our assets.
One of our investment tenets is that the asset is critical to the operation of the business, but to the same extent, we want it to be a generic asset that we could re-lease to anybody, which makes it a tough balancing act. For the majority of our transactions, we've been able to satisfy those two seemingly opposed criteria. In our flagship fund, Gramercy Property Europe, which has about €1 billion of assets, we only own one tenant-specific industrial asset.
We're one of the biggest investors in the logistics space in Europe. We believe that Europe is undeveloped in quality logistics and there's a great opportunity, particularly in funding of development transactions, of which we're doing more and more. I was talking to someone recently who knows this space very well, and his view was that the only limiting factor on the growth of e-commerce right now is the availability of institutional logistics space. Logistics is the flavor of the month, or year, but I think it's going to remain that way for a while.
We, like everyone else, have a concern that money is so cheap right now that developers are able to build to low rents and that existing stock is facing some reversionary pressure. We're always wary how cheaply a builder or developer is going to be able to build a building next door in five or 10 years' time, or whenever our leases come up.
What do you make of interest rates across Europe?
A change in interest rates is the biggest concern, as well as a change in the rate of change. Steady low interest rates are good for us at the moment. While this is creating a lot of competition and bringing a lot of capital to the market, it's also allowing us to capture extraordinary yield spreads. Interest rates will likely tick up a little bit, but it's difficult to see how they could surge. I expect we'll get little bits of inflation around the edges of the eurozone, but nothing like in the U.K., which is going to get inflation for all the wrong reasons. The inflation in Europe is not demand-led; it's currency inflation or imported inflation, if you like.
Where else do you see opportunities in Europe?
We're still very focused on industrial in Germany, the Netherlands and France. I think an appropriate strategy right now, if investors want to be in German, Dutch, French, or core Europe industrial, would be 30% to 40% new developments, specifically build-to-suit transactions. Then 30% to 40% of true but modern industrial, as in more traditional manufacturing, with longer leases but slightly more tenant-specific assets; and then the remainder of the portfolio in generic logistics that's already leased up and provides some other angle where we think one can create value.
We also see potential value in core, but not prime, logistics in the U.K. We think the U.K. is right at the forefront of the logistics evolution. I don't think you are necessarily able to create anything new in this market, but the U.K. market is massively land-constrained and it's extremely far along in the adoption of e-commerce. So we're seeing upwards pressure on rents in the U.K., which we're not seeing elsewhere in Europe.
Outside of industrial, there are various investment markets that have potential upside. One example is very high-quality office assets in secondary cities. There is very low spec development across Germany, the Netherlands and France, with reductions in office supply due to obsolescence and conversion of assets to other uses. We have seen a lot of opportunities recently for medium-sized assets.
One example was a headquarters building in Essen. The asset, located in the city center, is in a highly defensible location with a high-quality tenant on a long-term lease and a cost basis substantially below replacement cost.
While we do not think there will be material growth in rents in the medium term, the yields available result in very cash-generative investments.