The first nation to emerge from the pandemic, China suffered a severe lockdown but has returned to growth. The effect of covid-19 was to amplify existing trends for business and consumers towards domestic consumption and e-commerce, which has benefitted the logistics real estate sector.
Sun Dongping, chairman and chief executive of New Ease, a Chinese logistics developer and investment manager launched in 2018 in partnership with private equity group Warburg Pincus, and Derek Ng, head of capital markets at the firm, which has a more than 5 million square meter portfolio, talk to PERE about the sector’s post-pandemic performance and prospects.
How did the covid outbreak affect the Chinese logistics real estate market and how has it emerged from the pandemic?
Sun Dongping: China was first into the pandemic and, having implemented some really good control measures to contain the outbreak, we were the first out of the crisis. Economic data from the International Monetary Fund show China’s GDP growth will be over 8 percent this year and China is expected to overtake the US as the world’s largest economy in 2028. The logistics market was quiet in the first half of 2020 but has been gaining momentum since the start of the third quarter of 2020. Overall economic activity is now back to 2019 levels and, for logistics real estate, we have seen an increase in leasing demand for institutional grade logistics facilities.
Derek Ng: Demand from Tier 1 and 1.5 cities is notably higher than other areas in China, and we believe this is largely to do with the proximity of key consumption markets. By Tier 1.5 cities, we mean either the satellite cities of Tier 1 cities, such as Kunshan and Taicang near Shanghai or Langfang near Beijing, as well as key provincial capital cities such as Hangzhou in Zhejiang province, Nanjing in Jiangsu province, Wuhan in Hubei province and Chengdu in Sichuan province.
Were there developments which occurred during the pandemic which will be maintained for the longer term?
DN: E-commerce being a key driver for logistics real estate is not new, but the rate of increase in the adoption of e-commerce during the pandemic and the increasing requirement by tenants to have a more sustainable inventory are going to have some serious implications for our sector. By 2024, it is expected that 30 percent of overall retail sales in China will be e-commerce and this will translate into a transaction value of $2.7 trillion, comparing to 18 percent and $1.1 trillion in the US. We believe the tenants which will perform in the long term and have stronger leasing demand are those which have done well during the pandemic, those which have adapted their operations well and captured more domestic economic activities by digitalizing their businesses during covid.
“Location is always the most important factor… This brings us back to those Tier 1 and 1.5 cities, because these are the key consumption markets”
What are the important factors for investors to prioritize when looking at investing in China logistics assets?
SD: Location is always the most important factor. Investors are looking to maximize returns, which means they need both the underlying real estate to perform and a liquid market in which they could sell at the price they demand.
This brings us back to those Tier 1 and 1.5 cities, because these are the key consumption markets which have the highest tenant demand and where investors are comfortable investing. Sites are tough to acquire in these cities, but this makes the assets more desirable and means they have higher long-term value.
Tenants prefer locations that straddle at least two key consumption markets. So, for example, if you have a site in the Jinshan area in Shanghai, which lies between the city centers of Shanghai and Hangzhou, it doesn’t just cover the Shanghai downtown distribution, it can also cover Hangzhou. If there are goods to go to Hangzhou that are imported from the Shanghai ports or Shanghai airports, then the site can be a distribution point for these. The same theory applies to Langfang, which covers Beijing and Tianjin, and Dongguan, which covers Guangzhou and Shenzhen.
The manager matters, too. We are a strong believer in the fully vertically integrated business model, in which the manager is capable of taking care of the full investment cycle, starting from site sourcing and acquisition to development and construction, to leasing and property management and to investment management.
From the investor’s point of view, vertical integration creates synergies within the business itself, provides higher transparency and minimizes transaction costs. A proven track record and having a strong team on the ground are also important qualities of a good manager.
“From the investor’s point of view, we think that China logistics is still the most attractive sector given the risk-adjusted return across all asset classes and different jurisdictions”
Last but not least comes the asset quality and the tenant profile. While everyone (investors, tenants and ourselves) wants higher-quality buildings, to maximize the return, it is important to strike the balance between the quality of the building that tenants require, which is highly correlated to costs, and the maximum price that tenants can pay. For core investors, obviously tenant credit and contract terms are very important. Of course, the above-mentioned factors should be delivered in a total package by a qualified and experienced manager.
What is the outlook for China logistics real estate?
DN: After the pandemic, the Chinese economy is expected to play an even bigger role in the growth engine of the world. To understand how the domestic consumption market will drive the China logistics real estate market, we need to focus on what the consumers want from our tenants – which is convenience and new economy products. Location is the key to the former and the right type of tenants is the key to the latter.
SD: We expect our tenants to be more consumption-oriented, so there will be more demand for modern logistics facilities coming from cold chain logistics operators and also from new economy tenants, such as smart manufacturing tenants – like electric vehicle and medical device manufacturers – as well as pharmaceutical companies and new e-commerce companies. Food safety and healthcare are also two key elements that help shape our logistics sector going forward.
These tenants are demanding even more core locations than before, because on-the-dot delivery is valued by their customers. Given the speed of how these companies grow, they will also look for larger sites that allow for future expansion.
With limited land supply, the competition for land resources in prime locations will continue to be fierce. Nonetheless, there is also an increasing need to replace old facilities with new ones, partially due to the safety requirement by the local authorities.
DN: From the investor’s point of view, we think that China logistics is still the most attractive sector given the risk-adjusted return across all asset classes and different jurisdictions. Investors are aware of the key economic trends in China and there are more and more (onshore and offshore) market participants to provide liquidity in the market.
With the low interest rate environment prevailing, this market is getting more exciting than ever before. It is also worthwhile to note that sustainability is becoming a key trend as well. Both our tenants and investors would like their sheds to go greener.
SD: A question that is often raised by investors is how the e-commerce companies which buy and develop their own logistics facilities will affect our business. Demand for warehouses is definitely adversely affected but this comes again back to site selection.
We believe Tier 1 and 1.5 cities will be a lot less impacted given it is harder for these e-commerce players to get land and the demand for warehouses is generally higher and more sticky, as well as from a larger and more diverse group of tenants.
E-commerce players that acquire and build themselves in these areas account for a low percentage of our stabilized portfolio and we are very comfortable with that.
However, Tier 2 cities will be affected more given the supply-and-demand dynamics. The good news is that we are seeing other tenants and smaller e-commerce players not wanting to become asset owners, as they would rather focus on their core business.
DN: We are very optimistic about the outlook for China logistics. For a few years the world has been concerned about a black swan event. Now we have had it and China and its logistics real estate market have proven resilient.
We have weathered the trade war and think we have seen the worst of it, although we expect it to continue. The Chinese economy is definitely hurt in some ways but because we have shifted our growth engine and the mega trends have been accelerated. We believe this is what underpins the future of the China logistics market.
Why is tenant demand so concentrated on Tier 1 and Tier 1.5 cities?
Derek Ng: In addition to the e-commerce penetration, the pandemic has also accelerated the trend of China’s increasing reliance on domestic consumption. Even before the pandemic, China’s global exposure had been reducing as a result of geopolitical (US-China trade war) and other economic reasons (urbanization/consumption upgrade), but the pandemic has reinforced China’s focus on building up its domestic supply and demand.
Our tenants want to take advantage of the growing domestic consumption and the best places to do that are in Tier 1 and 1.5 cities. For our customers that continue to expand their businesses, having distribution points in these cities is crucial to their operation.