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Industrial REIT Segro expects its development programme and land bank to drive further growth across Europe in the second half of 2015 following a strong first six months which saw the company book higher operating results and portfolio values.

London-listed Segro announced on Tuesday that profit before tax rose to £330.0 mln (€464 mln) in the first six months of the year compared with £226.5 mln in the year-earlier period. EPRA NAV per share increased by 8.3% to 416 pence, reflecting strong investor demand for logistics real estate, asset management initiatives and development gains. The company recorded 4.3% like-for-like rental growth (including 5.8% in the UK) across the portfolio as a whole and positive asset revaluations across all its main markets.

Commenting on the results, Segro’s CEO David Sleath said: ‘2015 is shaping up to be another good year for Segro with strong operating metrics and portfolio performance, as the benefits of the portfolio re-shaping programme continue to be felt. We have experienced particularly strong demand from parcel delivery companies, third party logistics operators and retailers as economic conditions in our major markets continue to improve.’

In Continental Europe, where Segro is active mainly in France, Germany and Poland, the company’s completed portfolio returned capital growth of 2.3% in the first half, equivalent to the full-year increase booked in 2014. This compares with 6.9% capital growth for the UK portfolio, reflecting Segro’s strong weighting in London, the South East and the Midlands. Overall, the group’s portfolio increased by 6% in value to £5.2 bn.

A key highlight of the first half in Europe was Segro’s €39.6 mln acquisition of a 90% stake in Vailog, an Italian logistics developer with €103 mln of standing assets and land. ‘Vailog is a leading Italian player with good existing assets and land and an excellent track record. It gives us an immediate big box warehouse presence in the important northern Italian market, with opportunities to grow additional scale through development,’ Sleath told PropertyEU during a call following the publication of the results.

Focus on development
As economic conditions improve and occupier demand strengthens across its main markets, Segro is looking to development for future growth rather than acquisitions of standing assets. ‘As competition in the investment market grows, the returns we can generate from developments are increasingly attractive,’ Sleath said. ‘We will be looking to accelerate investment into the development pipeline, taking advantage of the market environment and securing pre-lets,’ he added.

Sleath noted that with prices for acquisitions rising in recent months, yields of 5.5-6% in Germany, for example, were becoming difficult to justify when yields of 8-9% could be achieved on developments.

Segro invested £46 mln in new developments during the first half of 2015, less than last year, but aims to speed up the pace of expenditure in the second half. The company completed eight projects totalling 125,200 m2 of new space in H1, of which 62% was let prior to completion. The projects will add £5.2 mln of gross passing rent when fully let, translating into a yield on total development cost of 9.8%.

Three of the development completions were of big box logistics warehouses pre-let to Asics in Krefeld, Zabka in Gdansk and Volkswagen in Poznan. Segro also completed 30,500 m2 of light industrial and urban logistics warehouses, including a 4,600 m2 parcel delivery centre for Deutsche Post in Nuremberg and two speculative schemes totalling 12,100 m2 on the Slough Trading Estate in the UK.

Sleath said Segro would continue to focus on both big box (70,000 m2 plus) and smaller urban warehouses, a combination it sees as distinguishing it from other players like Goodman and Panattoni which tend to concentrate solely on giant schemes. ‘We are the only ones to do both on a cross-border basis in Europe,’ Sleath said.

This polarisation between big and small schemes was the result, he said, of changes in the retail supply chain as retailers seek different ways of distributing their goods in response to the huge growth in ecommerce. 'Retailers want the traditional big sheds to cope with the huge demand in their online business. At the same time they also want smaller distribution facilities on the edges of towns - typically warehousing with cross-dock space - for smaller parcel deliveries closer to the consumer,' Sleath said. Demand for smaller - or last-mile - deliveries is growing as urbanisation increases and more young people move to the cities, he added.

Land bank is important
To facilitate development, a strong and well-located land bank was crucial, Sleath noted. ‘Yes, land is important but you also have to be careful not to have too much, as the lessons of the last crisis have shown. We have been adding selectively to our land bank with the aim of burning it through within a three- to five-year period.’ Segro’s land bank currently represents 6% of the company’s total assets, in line with the 5-10% range described as ‘manageable’ by Sleath.

‘As with all our land acquisitions, a key element of the appraisal process is confidence that the site can be developed within three to five years to avoid over-burdening ourselves with non-income producing assets,’ he said.

Segro added 153 hectares to its land bank in Greater London, the Thames Valley, Düsseldorf, Cologne, Paris and northern Italy in the first half, bringing its total future development pipeline to 445 hectares. The bulk of this expected to be developed within the next three to five years. Around 70% of the land bank is earmarked for development of big box logistics warehouses, with much of the remainder intended for light industrial development.

Former manufacturing sites
Redevelopment of former manufacturing sites in major cities is a route Segro is increasingly pursuing as good land can be hard to come by, Sleath said. ‘In Cologne, for example, we acquired the former campus of AkzoNobel to create our first light industrial estate in the city and the first three phases of development are already under way.’ In Düsseldorf, the company has agreed to acquire a plot of land which neighbours its RhinePark development. And in Paris, it bought an 18 hectare plot in the prime logistics hub of Garonor which was formerly a Peugeot Citroën manufacturing facility.

Segro's development programme is focused on pre-let schemes rather than speculative projects, Sleath said. ‘We don’t have the appetite to undertake large speculative developments.'

At end-June, Segro had 26 development projects totalling 332,400 m2 which were approved, contracted or under construction. The projects are 50% pre-let and due to complete in 2015 and 2016. The yield on total development cost is estimated at 7.9% when fully let.

The pipeline contains a 92,900 m2 warehouse pre-let to Leroy Merlin outside Milan, which Segro bought as part of the Vailog acquisition and the first phases of a new light industrial development in Cologne totalling 21,700 m2 of warehouse space.

Analyst comment
In a research note issued on Tuesday, Bank of America Merrill Lynch said Segro had made a strong start to 2015 with the company’s H1 earnings statement showing the company ‘is very much on the front foot’.

‘Having been positive on the stock for a while now, as we have seen the benefits of the strategic repositioning of the business coming through, we are glad √now to be able to focus on the future direction for the business, rather than on the disposal of non-core assets,’ the bank said.

‘With acquisitions getting increasingly expensive, the focus is shifting to further development activity as a route to further growth. With 445 hectares of development land, offering an 8.8% yield on a total development cost of £826 mln, we believe Segro has a healthy pipeline which avoids the need to acquire for the sake of it.’

The bank has retained its buy recommendation for Segro shares, which rose by 2.4% to around 442 pence on Tuesday following the earnings announcement.

Read also our interview with Andy Gulliford, COO of Segro