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Logistics CRE… The New Retail?

23 November 2017 by Aza Teeuwen

We have had to wait for over a year, but yesterday BAML finally priced the first European CMBS transaction of 2017. With the CRE loan market trading at tight levels – partly driven by Solvency II – the need for CMBS as a funding tool for CRE loans has been limited of late, so after a year of twiddling their thumbs, you can imagine that every single CMBS analyst/investor was all over this deal. After the marketing roadshow meeting we were excited, as deals such as this are rare and a great way to add diversification to our portfolios.

What made this Blackstone-sponsored transaction interesting was the type of collateral backing the 5 year mortgage; they called it “Last Mile Logistics”. Essentially these properties are smaller warehouses, located within a reasonable distance from the larger cities in the UK, facilitating delivery of products ordered online directly to consumers or local businesses. The idea is great, arguably driven by e-commerce, and more interesting than old-school retail outlets for obvious reasons.

The properties in this pool are of mixed quality and mainly built in the 1980s; it might be questionable how big the actual “logistics” exposure is as many of the tenants are active as local manufacturers and the building/construction exposure is reasonably high. Even though the warehouses are old, one can argue that replacement cost is limited and that you pay for the location. Given the age of the properties and tenancy profile, they require hands-on management and longer term dedication from the sponsor and the manager. M7, the asset manager in the deal, co-invested 5% in the equity so they are well aligned with Blackstone. If the strategy was to maintain and upgrade parts of the buildings, spend CAPEX and consider this as a long term investment to generate income, we would have been very happy to invest in this transaction.

However, Blackstone stated that their main business plan is to “build a portfolio of up to €6.5bn and sell the platform in the next 24 months” and they have already sold a similar platform to a Chinese investor earlier this year. We question the commitment from both the sponsor and the asset manager to be the hands-on manager that a portfolio like this requires. Given this is an aggressively structured cov-lite loan, lacking change of control clauses and any form of amortisation, there is a great deal of reliance on there being a strong and experienced new sponsor in 2 years.

The AAAs in the deal looked like reasonable value at Libor+0.85bps (with a 32% LTV at that level) but the BBBs at L+2.5% looked less appealing, even though they were 5x oversubscribed. The LTV at 58.5% at the BBB level doesn’t look too bad, but with only 12.9% relative debt yield, there is a significant risk that in a downturn scenario there could be shortfall if the properties have to be sold, as debt yield during the last recession was close to 14%/15%. That makes this a far from risk-free trade that could prove to be volatile in the coming years and a better entry point might present itself at that point in time.

So in conclusion; an interesting asset class and a great trade for the sponsor, but this is not the kind of strategy that we’re happy to fund through a cycle.

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