Many metrics across both capital and occupational markets are broadly comparable to pre-Covid levels, suggesting a normalisation in activity in the logistics sector.

Benchmark prime yields rose again this quarter in Los Angeles, Chicago, and Houston in the US, Hong Kong and Sydney in Asia Pacific, and London, Cologne, and the Île-de-France region in Europe. However, there is a sense that conditions are stabilising in many markets, particularly in the US.

Investors have not wavered in their conviction for logistics through this down cycle, but have rather chosen to sit out the volatility. The tide is beginning to turn. A yield of around 5% in the US, Australia, and the UK is beginning to look attractive again, given prospects for more stability in interest rates over the coming 12 months and continued upward pressure on rents.

Indeed, as evidence of this bottoming out in the cycle, interspersed through the overall decline in investment volumes this quarter were several major portfolio deals involving some of the largest asset managers in the world. This should help act as a catalyst for more activity in the second half of the year; where the big players go, others tend to follow.

Groundhog day

Inflation has peaked, and interest rates will soon reach a crescendo.

Sound familiar? That’s because there is a sense of déjà vu in the economic backdrop; since the beginning of this year, the narrative underpinning the global economic outlook has remained broadly consistent (notwithstanding a mini banking crisis in the US). Only the dates have changed. This is weighing on sentiment across real estate markets; investing in illiquid asset classes requires a level of conviction in the future that simply many are struggling with in the current environment. It’s no wonder that many investors are choosing instead to sit on their hands.

A paradox exists in the global economy which is making economists sound even more enigmatic than usual: good news is bad news, and bad news is good news. Economic growth has proven to be resilient this year, and incoming data has consistently beat expectations. But this is supporting ‘sticky’ inflation, forcing central banks to ratchet up interest rates in response. Expectations of the terminal rate have risen too, such that we are no closer to the peak than we were at the beginning of the year.

Slow burn downturn

An economic outlook that closely resembles what was expected at the beginning of the year implies that recession calls have been pushed back rather than removed completely. There remains an expectation, or indeed a conviction, that the rapid tightening of monetary policy over the last 18 months will have consequences. Better growth now merely delays the pain. Slower growth is a pre-requisite for inflation to return to target, so central banks will continue to push hard, even at the risk of causing a more severe downturn.

Indeed, the evidence would suggest that the drivers of economic resilience are beginning to roll over as we enter the second half of the year, meaning the slowdown expected at the beginning of the year was merely delayed.

Tighter credit conditions are feeding into interest-rate-sensitive sectors, such as housing. PMI activity data is slipping from recent highs, even in the services sector. In the US, weaker job growth and falling vacancies are starting to relieve some tension in labour markets and ease the upward pressure on wages. The euro area is already in recession after two consecutive quarters of negative growth. China’s economic recovery is stalling, and weak global trade is hitting growth in export-dependent economies across Asia.

This is good news for global inflation, and good news for those investors eager to see the end of the rate hiking cycle. It is also good news for global supply chains – which have largely fallen out of the news cycle – as weaker global goods demand eases the pressure on the networks supporting their production and transport. Businesses are reporting shortening supplier delivery times as a consequence, and freight costs are returning back to pre-Covid levels.

Return to normal

But it also implies a slowdown in the drivers of demand for logistics space, including the volume of global trade, which was down by nearly 2.5% YoY in May, according to the CPB World Trade Monitor, as well as retail sales. This is reflected in occupational demand, which is falling back from the exceptional, yet unsustainable, levels of recent years.

Markets that are inextricably linked to major ports, such as Los Angeles and Shanghai, are seeing a notable slowdown in take-up as container volumes fall in line with weaker trade growth. Sublease space is also rising in some markets, with many tenants finding themselves with more space than they need in an economy where household demand is rotating away from goods and towards services. Elsewhere, risk aversion is impacting tenants as well as landlords, leading to fewer large-scale new lease agreements.

With most markets seeing a slowdown in demand following the fervour of the last few years, differences in the supply backdrop will be important in dictating the prospects for continued rental growth over the next few years. In many markets, construction activity accelerated in the aftermath of Covid-19, given rock-bottom financing costs and strong growth in capital values.

Much of this new supply is only now hitting the market; in the US for example, construction starts peaked in Q2 2022 at around 220 million sq ft, and has only fallen below in the long-term average in this quarter.

This is putting upward pressure on vacancy rates, which have risen since the beginning of this year in the majority of markets covered by this report.

Fortunately, this new supply does not yet pose a significant risk to the short-term outlook, barring a more concerted decline in occupational demand, which is unlikely given some of the longer-term tailwinds, such as e-commerce and nearshoring, remain. In the UK, for example, while the vacancy rate has more than doubled in the last 12 months, this remains lower than the pre-Covid average, and is much lower than levels that in the past have triggered falling rents.

Indeed, in some markets such as Australia, investors are favouring assets with a short lease expiry, happy to take on the leasing risk in order to capitalise on the potential for upward revisions in rent. The markets where future supply is likely to be more disruptive include South Korea and Shanghai, and we expect further upward pressure on yields despite the stability in interest rates.

Sustainability remains a key consideration for both landlords and tenants, especially in Europe, where space will need to meet minimum energy performance standards to be lettable in the future due to rising regulation stringency. Investors and occupiers continue to focus more on best-in-class assets that meet their criteria.

_{Read the articles within Taking Stock: Capital Markets Quarterly – Q2 2023 below.}