Industry / Real Estate

Warehouse Real Estate (China)

Group Research / November 16, 2018

Photo Credit - AFP

Overall Outlook

China’s shift to a consumption-driven economy is generating strong demand for modern high-quality logistics properties. The consumer confidence index peaked in late 2017/early 2018 and has stayed at a relatively high level. Driven by this, online retail sales and foreign trade are rebounding, which should support demand for modern logistics properties ahead. On the other hand, new warehouse supply may slow as warehouse fixed asset investment (FAI) further declined by 8% in 9M2018, from a drop of 2% in 2017 after rising 5% in 2016 and 28% in 2015. The government’s intention to improve the efficiency of land usage in urban areas of top-tiered cities has led several cities to change local policies on industrial land use rights, which may further lower future industrial land supply, and thus, drive up existing warehouses’ valuations in those cities. Inland cities had reversed their downward trend in the latest two quarters, while coastal cities in Yangtze River Delta continue to lead rental upside.
While China-US trade tension has raised investors’ concerns over bilateral trade and hedging costs for foreign
investors, both domestic and foreign investors continued to show a strong appetite for logistics properties. The
pick-up in e-commerce growth has triggered industry-chain plays to compete for warehouse assets, leading to
further compression in capitalisation (cap) rates.

Online retail sales has kept above-expected growth. E-commerce retail sales is accelerating with 29% year-on-year (y-o-y) growth in 9M2018, vs. 31% and 26% expansion in 2017 and 2016 respectively, and iResearch expects a 21.3% CAGR in the next three years. Major e-retailers are actively expanding the categories of consumer goods, especially in fresh food and cross-border merchandise. They have further penetrated into rural areas and are exploring more opportunities there. In addition, major e-retailers are also expanding their consumer finance business, which could facilitate and drive online consumption activities further. Therefore, demand for warehouses should remain decent. During the latest Double 11 (Singles’ Day) Shopping Festival, gross merchandise value (GMV) for Alibaba (BABA US)/JD (JD US) grew 27%/26% y-o-y to Rmb213.6bn/Rmb159.8bn respectively, vs. market expectation’s low 20%.

Cold warehouses heat up. China’s manufacturing Purchasing Managers' Index (PMI) has remained above 50 for the last 28 months, indicating an expansion of manufacturing activities. Total monthly export/import activities have maintained their positive y-o-y growth since January 2017 to October 2018, based on the latest available figures. Imports increased by 20% in value terms in 10M2018 while exports grew 13%. Consumption upgrade continues to drive up demand for fresh foods and cross-border goods, and hence, supports demand for cold storage warehouses and bonded warehouses. According to iResearch, both online cross border sales (imports only) and online fresh food sales have registered strong growth over the past several years and are expected to grow >30% in 2018/2019.

Change in industrial land-use policy may lower future supply. Shanghai was the first city to lower the terms of industrial land-use rights from 50 years previously to 20 years in 2014. The city also plans to lower the proportion of industrial land from 27% currently to 17% by the end of the 13th Five-Year Plan (2016-2020). We also saw several cities following suit on Shanghai’s practice to lower the terms of industrial land use rights in late 2017 and early 2018, including Beijing, Guangzhou, Xiamen, Suzhou and Chengdu. In early 2018, Beijing also started encouraging the recycling/redevelopment of existing industrial lands for education, senior living and other social service purposes. We expect this to reduce future industrial land supply in those cities.

Warehouse continue to provide above-average cash flow returns among major asset classes; they also offer higher asset appreciation potential in the mid-to-long term. The development cycle of warehouses is much shorter than that of other asset classes such as offices and retail malls, offering more flexibility and defensiveness. In addition, it is possible for a warehouse to achieve a return on invested capital (ROIC) of 5-6% after one year of operation, higher than that of other asset classes. We also expect more appreciation potential for warehouse assets, as industrial land in China is still cheap as compared to other titled lands. In addition, logistics property assets continue to be sought after by domestic PE funds, foreign investors and upstream plays, which will continue to push up valuations and compress yields.

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