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As the real estate industry lags behind e-commerce sector LGP explores major implications of structural change.

29 April 2013

In today’s Property Market Differentials briefing, Legal & General Property’s (LGP) research team highlights the opportunities emerging for logistics property from structural change within the e-commerce industry, including challenges to traditional lease structures, emerging locations, more creative approaches, and greater consolidation and polarisation of retail operators.

Almost 20 years old and a $1 trillion market, e-commerce is a fast maturing industry, and yet the real estate sector’s response to it is still relatively embryonic.  Furthermore, the UK is the global leader in e-commerce, with between 10% and 12% of retail sales now occurring online, the annual equivalent of 60 million sq ft of retail space, rising to 20-25% by the end of the decade.  LGP identifies one of the reasons for the slow response of the real estate sector being the industry’s failure to take an integrated approach to retail and logistics, instead predominantly still choosing to treat them as separate disciplines, unlike successful retailers.  The first investors to do so are set to outperform.

Looking at the implications of this structural change, LGP identifies five key themes which it believes should influence investment strategies going forward:

1. Overall logistics demand will increase
E-commerce will drive an expansion in overall logistics take-up, although its nature will change as supply chains evolve. Investors will need to target this demand at an early stage and investigate build to suit solutions. Additionally, they will need to understand the potential of existing portfolios to see which buildings are most easily adapted to e-commerce needs to aid marketing and tenant targeting. The 3PL (third party logistics) sector is also intriguing and we expect consolidation within this sector, following which we believe covenants will strengthen.

2. There will be new logistics formats
LGP believes that there are four typologies that will emanate from e-commerce:
Dark store demand will increase close to population centres and investors will need to work with grocery operators to procure and develop sites;
Demand for regional e-fulfilment centres will strengthen and, where automation and specification increases, longer leases will be achievable;
Demand for urban distribution centres will grow as goods are sorted and sent on to home or collection destinations;
New innovative collection formats will be established, for example with drive through grocery collection points on business parks and trade parks, and investors will need to enable flexibility within their portfolios to enable these, potentially involving the adaption of existing units.

3. There will be new, measurable location drivers
Investors can use demographic data to predict areas which best suit the four logistics types, such as skill, affluence, age distribution, population density, car ownership and broadband access.  By weighting the attributes differently for the different target logistics sectors, new geographies are expected to emerge.

4. There will be new rules for specification
E-commerce has changed the definition of “prime product” from "the best space in the best location" to “a building which reduces the unit cost of delivery to as low a level as possible”, thus internal specification has become far more important. Operational risks will therefore rest increasingly with the occupier but investors will also need to enable these specification requirements.

5. New leasing contracts will emerge
Shorter leases can be expected on logistics assets with limited specification and for 3PLs reliant on contract length. More automated units, however, will require longer leases to justify cost amortisation.  In addition, covenant strength will relate to online ability. Investors will need to evaluate occupiers' operations across the whole supply chain from the point of purchase.

Bill Page, Business Space Research Manager at Legal & General Property, comments:  “E-commerce is a rare example of true structural change.  This revolution in consumer behaviour will take time to play out in physical real estate, but the opportunities for logistics are compelling.  The ability of landlords / investors to understand demographic drivers, as well as to take a more creative stance to leases, evaluation of covenant strength and site options, will all therefore become increasingly important factors that determine the winners and losers within the sector, and investors’ share of the expanding logistics market.”

Notes to editors

Legal & General Property (LGP) is a wholly-owned subsidiary of Legal & General Investment Management (LGIM), one of Europe’s largest institutional asset managers and a major global investor. LGIM manages approximately £406bn of assets on behalf of more than 3,300 clients (31 December 2012) and provides products and solutions spanning all asset classes. LGP is the third largest institutional property fund manager in the UK, managing or co-managing 16 separate funds or vehicles and two segregated mandates with an aggregate asset value of £10.4bn as at 31 December 2012.

These funds include:

Specialist Pooled Funds
The Leisure Fund Limited Partnership; Industrial Property Investment Fund; Arlington Business Parks Partnership; and the English Cities Fund

Single Asset Vehicles
Bracknell Regeneration Partnership; Central Saint Giles Partnership; Performance Retail Limited Partnership and Warrington Retail Limited Partnership

Balanced Funds
Life Fund; Linked Pensions; Linked Life; Managed Fund; Property Unit Trust; UK Property Income Fund; LPI Income Property Fund and the Hybrid Property Fund

LGP’s UK-focused fund management platform has built and retained a strong track record of out-performance across the sector. Owing to its size, diversity and penetration, it benefits from best in class banking and property industry contacts which, along with its wealth of in-house skill and expertise, have enabled it to continue to attract and secure high quality market opportunities. Taking a client-centric approach, the business places the highest priority upon integrity and transparency, leveraging upon the significant resources provided by the wider LGIM platform. Sector specialists cover each sphere of the market and are supported by LGP’s market-leading research capability.

LGP’s sector specialisms cross all facets of the real estate market. In particular, the Company has a major development platform, responsible for delivering the West End office market’s latest landmark, Central Saint Giles, and currently involved in developing its high profile Covent Garden scheme, Agar Street, as well as significant town-centre retail and leisure regeneration projects, including Bracknell, Trowbridge, Northampton and Eastbourne.

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