Offices yield to warehouses as Covid-19 changes UK real estate

London

ON A building site about 32 km east of London, workers are busy putting up the largest warehouse in Europe. Just leased to Amazon.com, it cannot go up fast enough.

When it is done next summer, the four-story "mega-box" will encompass 214,000 square metres (sq m), the size of 40 American football fields. Developer Tritax Big Box Reit had plenty of interest from retailers in the site on the River Thames, but when Amazon came knocking, the rest were pushed aside.

A development on this scale during the UK's first recession since 2009 highlights how the growth of e-commerce has helped make warehouses one of the hottest assets in real estate. Demand for these properties hit a record in the second quarter as online shopping spiked during lockdown. The value of the rent they are bringing in is surging at more than twice the rate of offices.

"The pandemic has accelerated the shift in consumer habits to online, which means online retailers' demand for warehouse space in the UK is increasing at unprecedented levels," said Jonathan Compton, senior director for UK industrial and logistics intelligence at broker CBRE Group. "This sector is undoubtedly a key area of growth for real estate investment."

The United Kingdom has led the e-commerce boom in Europe, and warehouse builders and operators have reaped the benefit. Landlord Segro has seen its shares soar over the past five years. It is now worth about £11.5 billion (S$20.7 billion), making it the country's most valuable listed property firm. The market has also attracted global giants including Blackstone Group and Prologis, which runs a logistics park next door to the Tritax site in Dartford.

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By contrast, the rise of online shopping has battered traditional retailers and their landlords, most dramatically in the case of Intu Properties. The owner of nine of the UK's top 20 shopping centres collapsed into administration in June after failing to reach a deal with its creditors. Other firms are also struggling, such as Hammerson, which is raising money to help it through the pandemic.

Covid-19 threw this trend into overdrive. Internet sales accounted for 20 per cent of all retail purchases in February, before the UK government shut down much of the economy to slow the outbreak, Office for National Statistics data showed. In June, the number was 31.8 per cent, with average weekly sales of £2.5 billion.

Driven by this Internet shopping spree, the demand for warehouses climbed to a record 1.19 million sq m in the three months till June, with online retailers taking up nearly half of that space, CBRE said. Amazon alone accounted for 36 per cent of the market in so-called big-box facilities in the first half of this year, Savills said.

"We're seeing a massive change in the way people perceive logistics. Twenty years ago, it was the ugly duckling," said Andrew Parsons, who manages over US$3 billion in assets at the Nedgroup Investments Global Property Fund. Now, warehouses are "prime pieces of real estate with massive amounts of capital being put to work", he added. "It's remarkable the reordering of the real estate pecking order."

The growth in demand is being fuelled not only by online retailers, but also by traditional merchants ramping up their internet businesses to adapt to the post-Covid economy. John Lewis Partnership, which is closing department stores and cutting jobs, has said it expects online sales to account for 60 per cent of total trade, up from 40 per cent before the coronavirus.

"Whether it's for PPE, virus-testing kits or everyday essentials, some supply chains were found wanting during the pandemic, and we are seeing a renewed focus on this by governments and businesses alike," Segro chief executive officer David Sleath said. The result will be more production in the UK and more inventory held locally to prevent disruptions.

"Brexit and global trade wars will only add to these pressures, and that means more warehousing demand in the future," Mr Sleath said.

With the UK mired in a recession, the government trying to prevent a second wave of infections and the looming possibility of a no-deal Brexit further damaging the economy, the outlook for real estate is uncertain. Yet firms in the logistics sector are betting that the changes that have reshaped consumer spending during the pandemic will become permanent.

While Internet spending will probably come down slightly from its lockdown highs as brick and mortar shops reopen, it is still expected to remain at about 28 per cent of total retail sales, said Len Rosso, head of industrial and logistics at Colliers International Group.

For every £1 billion spent online each year, another 88,300 sq m of warehouse will be needed, CBRE estimated. But the supply of warehouses is tight, especially so-called last-mile facilities located on the fringes of towns and cities. This is an area where UK firms are competing with Blackstone. It started as a company last year called Mileway, which is the largest last-mile logistics real estate company in Europe, its website said.

Urban warehouses are "a huge area where we obviously need a lot more capacity", said Bloomberg Intelligence analyst Sue Munden. "Demand there is still very strong, and I think rents will continue pushing up."

For Tritax, this means Amazon will pay a rent premium for its Dartford warehouse, which is located inside London's M25 ring road, said Bjorn Hobart, a partner at the developer. With this one deal, Tritax locked in the profit expected from the entire site, which has planning permission for another 41,800 sq m shed and space left over.

The site's location and the demand for warehouses also afford Tritax a luxury that few UK landlords have these days: the ability to be choosy about its next tenant. The developer has turned down "many offers" for the smaller plot in Dartford, and is holding out for "high-quality" tenants.

"We feel we can achieve better," said Mr Hobart. BLOOMBERG