To aim to provide a regular and attractive level of income return together with the potential for long term income and capital growth from investing in high quality European logistics real estate.
Logistics has been one of the most heavily sought- after sectors by investors in recent years. In 2022, logistics accounted for 19% of all Commercial Real Estate investments, a substantial increase on the 9% seen in 2015. However, the €39 billion of logistics deals closed in the year to June 2023 represented a 50% decline on the previous 12-month period. Investment market liquidity is currently lower than previous years given the mismatch in buyer and seller pricing expectations, with yields still to peak due to inflationary pressures and interest rate increases. Where values have fallen the most and where yields have broadly stabilised, we are starting to see more deal activity. Values in the Netherlands have fallen roughly 30% and some investors already consider this area to be offering better value today. Currently, the lowest yields can be found in Germany (4.4%), the Netherlands (4.5%) and France (4.6%); while yields in Spain and Poland are increasing and now stand close to 5% and 6%. In parts of Western Europe outward yield shift has slowed as 2023 has progressed, and with interest rate hikes moderating, transaction based indices from Green Steet suggest that the correction in values is close to stabilising.
Recent stability can be put down to several factors. One of those is that logistics yields have now caught up with all-in debt costs in many markets. We estimate that logistics financing can be sourced at roughly 4.6% on average in core markets, based on the Eurozone five-year swap rate of 3.2% (as of August 2023) and bank lending margins quoted at 140 basis points on good quality and well-let properties. Average prime logistics yields are now 5.1%, so a positive spread has been re-established, even if interest rates remain elevated. Central and Eastern European markets and riskier assets remain more costly and tougher to finance. There are more refinancing issues and distress to come, as well as a possible increase in margins in the event of a harsh recession, so it is too early to say that leverage is no longer a hindrance. The logistics sector is showing signs of slowing down in line with the economic backdrop. The Eurozone Manufacturing PMI fell to 42.7 in July 2023, from 43.4 in the previous month, the lowest level in three years. It reflects a continuation in manufacturing slowdown that has now lasted a full year. Looking deeper at the drivers of demand, 2022 e-commerce sales growth beat expectations to reach 12.8% in Europe. This took the e-commerce sales penetration rate to a new high of 18.2%. Had it not been for a sharp retrenchment in e-commerce sales penetration in the UK, the aggregate numbers would have been even more impressive. Germany led the growth on the continent with a 265 basis point increase in e-commerce sales penetration, taking its total to 18.5%. France and the Netherlands also experienced strong growth of 180 basis points each, taking their penetration rates to 15.5% and 21.5% respectively. However, this growth rate has slowed in 2023 as economic challenges, weaker labour markets and higher household indebtedness have impacted household finances. At the same time e-commerce capacity is moderating back towards more typical pre-pandemic levels. Amazon has been sub-letting space in the UK and Germany and vacating some of its older and less efficient stock. The European average e-commerce sales growth rate is forecast to drop back to 6.6% in 2023, before accelerating again towards 10% per annum in 2024 and 2025. The growth in demand for modern logistics assets has become much more than just an e-commerce story.
A much broader supply chain configuration is taking place, Supply chains are adjusting to reduce risks and costs, and that means warehouses need to be closer to customers and have to perform efficiently. With the rise of improved data handling, automation, robotics and other technologies, logistics operators and suppliers can create more efficient supply chains with fewer risks of costly delays. This requires modern warehousing in new and established locations. This supply chain modernisation is ongoing, and we expect it to sustain the current demand and supply imbalance over the long-term. Vacancy rates are still low and the availability of best-inclass warehouses remains scarce. The European vacancy rate is up slightly from a record low of 2.6% in the first quarter of 2023, to 3.5% in the second quarter of 2023; we expect that figure to edge up a little further, but to remain at comparatively low levels. Completions totalled c. 7% of stock in 2022 and are likely to reach a similar level in 2023. European logistics rents have on average increased by over 30% over the last five years and most markets are still experiencing growth today. Rents increased by 30% in Warsaw over the year to Q2 2023, while Germany’s major cities experienced a 20% increase on average. Sweden, Finland, the UK and Ireland reported rental growth in excess of 10%. It is common for logistics leases in Europe to carry indexation clauses that mean passing rents increase with inflation year-on-year.
Portfolio activity / Asset management
While H1 2023 has been a period of volatility due to high inflation, rising interest rates and falling capital values, it has been a busy period for our local asset management teams. The Company’s first asset sale of Leon in Spain, together with four new leasing transactions in France, the Netherlands and Poland, have generated positive asset-level returns in a challenging market. These five transactions have enhanced the portfolio metrics, improving the WAULT to break from 6.1 to 7.1 years and the WAULT to expiry from 8.3 to 8.7 years. The leasing transactions totalled 80,819 sq m of space, generating in excess of €5m of annualised income. Early in 2023, the Company agreed a 3,939 sq m lease renewal with Dachser France, the international provider of transport and logistics solutions, at its urban logistics freehold property at La Crèche, near Niort, France. Dachser signed a new 9.5-year green lease, effective January 2023, which generates annual contracted rent of €532,900, and which was 3% ahead of the previous passing rent. Importantly, the new lease provides for annual uncapped French ILAT indexation with increased payments commencing in 2025, backdated to January 2023. The property sits on 44,000 sq m of land (with only 9% site coverage), providing good opportunities for future expansion and/or future development. In May the Company agreed a new 28,500 sq m green lease extension with Biocoop, the leading organic food distributor, at its warehouse near Avignon, France. The new 12-year lease, effective from 1 March 2023, generates an annual contracted rent of €2.5 million and provides for full annual French ILAT indexation with no cap. Avignon serves as a strategically important location for Biocoop, which operates a unique multi-professional cooperative model, supporting a network of over 570 organic stores promoting local production in order to limit transportation and support local economies. The property also generates €165,000 per annum of additional income from rooftop solar panels. We were very pleased to reaffirm our relationship with such a sustainability focussed tenant, and the renewal added clear value. In May we completed the Company’s first asset sale, disposing of our 32,645 sq m warehouse, in Leon, Northern Spain, to SCPI Iroko Zen, for €18.5 million. The disposal price reflected a 3% premium to the 31 December 2022 valuation. The Company acquired the asset in 2018 for €15.3 million with the sale reflecting a crystalised 20% gross profit. Located in the Villadangos industrial area, it was leased to Decathlon with a WAULT of six years. This transaction reduced the LTV and improved the cash position, whilst increasing the portfolio’s urban logistics weighting. During the period the Company also agreed a 5-year lease extension with Dutch retail and pharmacy operator Kruidvat at its 39,840 sq m single-tenant warehouse in Ede, the Netherlands. The new deal extended the lease expiry from 2028 to July 2033, generating additional income as well as reflecting a 4% increase on the previous passing rent and providing for future upward-only indexation capped at 4% per annum. In Krakow, the Company agreed a three-year lease extension with Maxfliz, one of Poland’s leading interior design businesses. This deal moves the lease expiry to July 2027, further enhancing the portfolio WAULT metrics.
Discrete Performance (%)
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The Company launched on 15 December 2017, therefore discrete performance figures are not available for full years prior to 2018. Share price total return is on a mid-to-mid basis. Dividend calculations are to reinvest as at the ex-dividend date. Source: abrdn Investments Limited, Lipper and Morningstar. Past performance is not a guide to future results.
Environmental, Social and Governance (ESG) has been embedded in our strategy since listing, and it is an area where we continue to perform well. The Company achieved a score of 86/100 and a 4-star rating in the 2022 GRESB survey which placed the Company second in its peer group of six listed logistics strategies in Europe. GRESB is the Global Real Estate Sustainability Benchmark assessment and a leading indicator worldwide for measuring green performance. The Company’s continued year-on-year improvement from 84 to 86 points is an excellent achievement. Our starting point was strong thanks to the younger age of the portfolio and the installation of solar panels on ten of our buildings. Our dedicated abrdn ESG team is helping to optimise the sustainability credentials of the portfolio and we hope to improve our score this year. We are also seeing, as corporates continue to evolve their own sustainability pathways, that the requirement for space that supports these strategies is becoming par for the course. We are concluding work on defining a Net Zero Carbon strategy with the Board with clear reduction targets for the future. We have undertaken a pathway analysis with a third party specialist in this field. Knowing the carbon footprint of each building in the portfolio helps guide towards creating a real structure to our environmental and sustainability ambitions for both the near and long-term.
We remain positive on the long-term demand drivers from e-commerce, near-shoring, supply chain diversification and modernisation. The reconfiguration of supply chains, driven by the need to adapt in the face of pressures such as technological change, e-commerce and deglobalisation, is a process that should drive strong demand for modern logistics properties for some time to come. Following the 20% decline in All Property1 values since June 2022, the yield revaluation phase appears to be closer to the end than the beginning, although risks of another step down are elevated because of the weakening economic outlook and the ongoing difficulties in debt refinancing. We continue to monitor loan covenants, which are seeing pressure from continued yield movement, but mitigants including loan repayment and additional security remain options if required. Logistics is expected to outperform the EU average All Property total return with 7.8% per annum over the next three years and 7.6% per annum over five years. This is mainly driven by income returns and modest capital growth prompted by a balance of yield compression and income growth. The use of financial leverage today is not particularly attractive given elevated interest rates and persistent downside risks to the market. We think that interest rates more widely should peak in late H2 2023, before falling back gradually in 2024. Our all-in fixed debt at 2% per annum stands us in good stead and our earliest refinancing is only required in June 2025. However, we remain alive to the fact that rates may not stabilise back to previous low levels, and we are working with the Board to use all levers available to us to improve dividend cover. We continue to expect a threephase outlook: . Yield revaluation – we believe that the yield correction is roughly three-quarters of the way through, although price discovery will take more time as liquidity remains low. . Economic recovery – Eurozone recession expected in Q4 2023/H1 2024, followed by a recovery; interest rate expectations have fallen back and a cutting cycle is expected in 2024. . Supply-driven rental rebound – lack of supply to support rental growth prospects while sticky inflation is supporting real income growth. Given the elevated risk levels and the delay in the turning point in 2024, we currently believe in a low-risk approach. We believe that attractive opportunities will arise for investors over the next six to twelve months, and so being ready to take advantage of better pricing entry points will be crucial. We expect logistics to be one of the best performing sectors over the medium term, given the structural pressures behind demand. Units of between 20,000 to 40,000 square metres in fringe city locations currently represent the most ‘liquid’ part of the logistics market from both a leasing and investment perspective and offer robust performance prospects in the long run.
Principal risks and uncertainties
The principal risks and uncertainties affecting the Company are set out on pages 13 to 17 of the Annual Report and Financial Statements for the year ended 31 December 2022 (the “2022 Annual Report”) together with details of the management of the risks and the Company’s internal controls. Notwithstanding the risk of recession, higher inflation and tenant rental negotiations discussed in the Chairman’s Statement and Investment Manager’s Review, these risks have not changed materially and can be summarised as follows: . Strategic Risk: Strategic Objectives and Performance; . Investment and Asset Management Risk: Investment Strategy; . Investment and Asset Management Risk: Developing and Refurbishing Property; . Investment and Asset Management Risk: Health and Safety; . Investment and Asset Management Risk: Environment; . Financial Risks: Macroeconomic; . Financial Risks: Gearing; . Financial Risks: Liquidity and FX Risk; . Financial Risks: Credit Risk; . Financial Risks: Insufficient Income Generation; . Regulatory Risks: Compliance; .Operational Risks: Service Providers; and .Operational Risks: Business Continuity. The Board also has a process in place to identify emerging risks. If any of these are deemed to be significant, these risks are categorised, rated and added to the Company’s risk matrix. The Board notes the Investment Manager’s robust and disciplined investment process which continues to focus on high quality warehouses located across Europe and prudent cash flow management.
The Board is mindful of ongoing events involving Russia and Ukraine which have caused significant market volatility across Europe and the World. There has been no discernible impact to date on our tenants located in Poland and across the wider region. The Board, through the Manager, closely monitors all third party service arrangements and has not suffered any interruption to service. The Board therefore believes that the Manager and all other key third party service providers have in place appropriate business interruption plans and are able to maintain their service levels to the Company. Related party transactions aFML acts as Alternative Investment Fund Manager, abrdn Investments Ireland Limited acts as Investment Manager and Aberdeen Asset Management PLC acts as Company Secretary to the Company; details of the service and fee arrangements can be found in the 2022 Annual Report, a copy of which is available on the Company’s website. Details of the transactions with the Manager including the fees payable to abrdn plc group companies are disclosed in note 16 of this Half Yearly Report. Going concern In accordance with the Financial Reporting Council’s Guidance on Risk Management, Internal Control and Related Financial and Business Reporting, the Directors have undertaken a rigorous review and consider that there are no material uncertainties and that the adoption of the going concern basis of accounting is appropriate. The Directors are mindful of the principal risks and uncertainties disclosed above and have reviewed forecasts detailing revenue and liabilities. While the Company is obliged under its articles to hold a continuation vote at the 2024 AGM, the Directors do not believe this should automatically trigger the adoption of a basis other than going concern in line with the Association of Investment Companies (“AIC”) Statement of Recommended Practice (“SORP”) which states that it is usually more appropriate to prepare financial statements on a going concern basis unless a continuation vote has already been triggered and shareholders have voted against continuation. Accordingly, the Directors believe that it is appropriate to continue to adopt the going concern basis in preparing the financial statements. In coming to this conclusion, the Board has also considered the residual impact, where feasible, of the COVID-19 pandemic and other geopolitical economic turbulence. The Investment Manager is in contact with tenants and third party suppliers and continues to have a constructive dialogue with all parties. A range of scenarios have been modelled looking at possible impact to cash flows in the short to medium-term and the Board has set limits for borrowing and regularly reviews financial modelling scenarios and the level of gearing. The Directors believe that the Company has adequate financial resources to continue in operational existence for the foreseeable future and at least 12 months from the date of this Half Yearly Report. Accordingly, the Directors continue to adopt the going concern basis in preparing these financial statements.
Directors’ Responsibility Statement
The Directors are responsible for preparing this half-yearly financial report in accordance with applicable law and regulations. The Directors confirm that to the best of their knowledge: . the condensed set of financial statements contained within the half-yearly financial report has been prepared in accordance with UK adopted International Accounting Standard 34 ‘Interim Financial Reporting’, and the Disclosure Guidance and Transparency Rules sourcebook of the United Kingdom’s Financial Conduct Authority and gives a true and fair view of the assets, liabilities, financial position and net return of the Company as at 30 June 2023; and . the Interim Board Report (constituting the interim management report) includes a fair review of the information required by rule 4.2.7R of the UK Listing Authority Disclosure Guidance and Transparency Rules (being an indication of important events that have occurred during the first six months of the financial year and their impact on the condensed consolidated financial statements and a description of the principal risks and uncertainties for the remaining six months of the financial year) and rule 4.2.8R (being related party transactions that have taken place during the first six months of the financial year and that have materially affected the financial position of the Company during that period).
Risk factors you should consider prior to investing:
Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London, EC2M 4AG. abrdn Investments Limited, registered in Scotland (No. 108419), 10 Queen’s Terrace, Aberdeen AB10 1XL. Both companies are authorised and regulated by the Financial Conduct Authority in the UK.