From Lease Structures To When To Stop Investing: Inside Blackstone’s Logistics Strategy

When you've gone really big in a sector, how do you know when to stop? 

Of all the conviction bets Blackstone has made over the past decade, logistics has been the biggest.

The U.S. private equity giant has invested tens of billions in the sector around the world, and reaped the reward, selling or recapitalising platforms and portfolios at huge profits.

At Bisnow’s Industrial & Logistics Transformation event on Tuesday, Blackstone Senior Managing Director Peter Krause talked through the firm’s strategy in the UK and beyond, including views on rental growth, inflation and lease structures, cap rate compression and the key signal to watch as to when to stop investing. Here’s the deep dive.

Current Price Levels Can Be Maintained

Industrial prices have appreciated sharply in the past decade, and last year, values increased a staggering 40% for London and South East industrial assets, CBRE said. While growth in the sector will come more from rents rising than yields falling in the next few years, there is no reason why cap rates should expand, Krause said. The U.S. provides a positive template. There interest rates and government bond yields have gone up, but industrial yields haven’t been pushed up as a result.

“There is some buffer for cap rates to remain steady or even compress,” he said. “If you had asked me 12 months ago would they compress further I would have said no, but they did.”

Rental Growth Set To Continue

In London and the UK, things look set fair for rents to continue to grow strongly, even on top of recent years of growth. The vacancy rate for big-box logistics is just 2% in the UK, Krause pointed out, and there are even predictions that London will run out of new industrial last-mile space. At the same time, demand continues to grow, with an ever-increasing number of e-commerce businesses promising ever-shorter delivery times.

On top of this supply and demand dynamic, the cost base of the average logistics occupier, in urban logistics in particular, also needs to be borne in mind.

“It’s important to re-emphasise what a large chunk of costs fuel and transport are for the occupier base,” Krause said. “It’s 50-60%, whereas rents are 5-6%, so by reducing drive time by being closer to city centres and thus reducing fuel costs, they are able to absorb those rental increases.”

Lease Structures Are Key, Especially In Times Of Inflation

Krause said in the current time of high inflation, industrial is at an advantage over other sectors: that inflation can be passed on to occupiers in industrial and logistics, because the occupier base is growing and the dynamic between supply and demand is in the favour of landlords.

“We think industrial rents will outpace inflation,” he said.

But he also went deeper and gave an insight into how Blackstone thinks about the leases it offers tenants. At a time of high inflation, you might think inflation-linked leases, where rents rise annually in line with consumer-price inflation, offer the best way to capture rising rents. 

“We actually think the opposite,” he said. “The fundamentals for logistics are so strong that we think that open-market rent reviews are the best option in terms of capturing that uplift.”

He added that shorter leases with rent reviews occurring frequently are the ideal, giving the landlord the most control in terms of generating income growth. 

Still Buying? Yes, And The Sector’s Rerating Is Here To Stay

Krause said that Blackstone will carry on being a significant investor in the sector, and it has a great deal of conviction in industrial’s future.

“There are a number of sectors we are quite bullish on,” he said, naming film studios, life sciences and data centres. “But on a global basis, logistics is one of the top.”

He added that the stable income from the sector, potential for rental growth and the low capital expenditures required for industrial properties compared to other sectors mean yields for industrial assets are lower than those for offices and retail, and that is likely to persist. 

How Can You Still Make Opportunistic Returns?

Given the weight of capital chasing the logistics sector, and that price appreciation, is it still possible to make opportunistic returns? Yes, Krause said, Blackstone is still buying for its opportunity funds in the logistics and industrial space.

“We’re still buying assets that have significant reversionary potential when it comes to rents, and we’re working with best-in-class operators like St Modwen [which Blackstone took private last year] to undertake judicious new development where we think it’s appropriate,” Krause said. Buying older stock and improving it also offers the potential to improve rents and values, he said.

You Can Still Build Another Big Industrial Business

Blackstone made big profits building up a big-box logistics platform, Logicor, and selling it to China Investment Corp. in 2017, and is in the process of recapitalising or selling its €21B Mileway last-mile business (a deal which Krause couldn’t speak about because the process is ongoing). In spite of fierce competition, building portfolios is still possible.

“We’re working with a lot of repeat sellers we’ve worked with before, and the team is working hard to turn over every rock and stone to find new deals,” he said. 

When To Say Stop

“No one knows how long the growth can go on for in the sector; it’s impossible to predict that,” Krause said on the question of when the supercharged market might start to lose its lustre.

But he does know the signal he’ll be watching above all others.

“I think its vacancy rates,” he said. “It’s difficult to say anything else could be more important. There is going to be new supply, but there is also going to be new demand. So it is watching those, making sure they don’t trickle up, and obviously right now, they are close to zero.”