Quality Warehousing Services got boost with major Infrastructure Push in Railways: says Nilesh Karkhanis, Milestone Capital

Institutional interest in Logistics, Warehousing to grow in the backdrop of expected manifold rise in activity levels in warehousing segment with several institutional players are keenly eying the opportunity. We are expecting government’s infra push to drive demands.

MUMBAI: With government’s recent policies including Make in India, Bharatmala project and most importantly implementation of the Goods & Services Tax, we are seeing increased activity in the warehousing and logistics space. In the backdrop of expected manifold rise in activity levels in this segment going forward, several institutional players are keenly eying the opportunity. Milestone Capital Advisors, a homegrown real estate fund, is one of the few institutional players to have already funded and participated in warehousing segment. Nilesh Karkhanis, Partner – Milestone Capital shares his views on the outlook for this sector.

In the current real estate scenario, which segments are institutional investors keen to participate in?

The institutional realty investor continues to explore new horizons against the backdrop of positive tail winds in Indian industry and trade. A slowing sales volume and high unsold inventory has impacted the residential segment and private equity investors are spreading their real estate exposure in multiple asset classes.

We have seen renewed interest in pre-leased offices due to attractive capital values and stabilized rental yields. Strong demand for Grade-A office space especially in CBD areas, low vacancy levels and limited supply of offices has brought this segment back in favor for the investors. We have seen the share of offices in overall investments rising from 18% to 35% in just two years. With not much supply expected, the demand supply mismatch will fuel growth in capital values of Grade-A office assets.

Another upward swing is noticed in urban infringes. There is sustained escalation in land prices in these areas. As more and more infringes are brought under Development Plans and Regional Plans for organized urban growth and industrial promotion, the land prices are bound to steadily increase. However, mere land aggregation and speculation will not give double digit returns and liquidating raw land continues to be a challenge, especially for institutional buyers. Investment opportunities in urban infringes will primarily be in affordable housing and logistics & warehousing parks.

What do you see as key demand drivers for warehousing?

There are definite statutory initiatives of central and state governments to attract investments in warehousing and logistics, both directly and indirectly through policy framework. As mentioned above, new urban infringes growth centres are being planned with specific land use demarcation for logistics and warehousing. This zoning is coupled with supporting industrial zones and transport networks. This shall be further accentuated by the recently announced Bharatmala Pariyojana that includes 50 new national corridors and multi modal logistics parks across the country.

With the advent of GST, certain sectors have become poised for speedy growth. Logistics and warehousing is such a sector. Arguably, no other industry has benefitted more by GST than the warehousing and logistics industry. Since the advent of GST, the warehouse selection has become agnostic to location. Warehouse parks can now be developed in tax neutral environment and their setting up will be governed primarily by land cost and connectivity. With one nation one tax, locations are being selected by end users on the basis of optimum logistics route and availability of quality warehouses in such locations. We shall see a significant change in the logistics and supply network including moving towards hub and spoke model thus creating a demand for large centralized warehouses and distribution centres. However, these can only be delivered through integrated logistics parks developed through an organized platform.

Further, we are seeing significant investments in infrastructure with focus on adherence to project timelines. This $100 billion infrastructure push in roadways, railways, ports, air cargo terminals etc., has provided a boost to the demand for quality warehousing services. The Make in India initiative, though in an early stage currently, is another big driver for warehousing and logistics demand. Though a lot remains to be achieved in these areas, the sentiment is positive.

With these fundamental changes being effected, there is an opportunity for institutional developers and institutional investors to develop large format warehouses.

As warehousing industry has mainly been on an unorganized platform, how do you see an institutional player leverage this opportunity in warehousing?

According to various industry reports, the warehousing industry is slated to grow at 8% to 10% per annum for the next few years. But the fine print of all the available data and our firsthand information indicates that this growth will not be uniform across geographies and segments. There is a clear cut focus of FMCG, e – commerce and electronics industry players to move towards consolidation. Other growing industries continue to depend on third party logistic players, who in turn are trying to build long term relationships for de-risking their business model. Additionally, more warehouse users are seeking integration of leasing with added support services. This means investment in warehousing development shall be done keeping in mind the long term business requirements of users.

Though there is an opportunity for sustained returns, offshore and domestic investors will need experienced partners and asset managers in warehousing.

What is your strategy for new warehousing investments vis-a-vis location and other factors?

I see that land parcels as far as 15 to 30 kms from urban boundaries can now be developed into logistics parks as long as they enjoy proximity to highways and rail networks. With GST in place, the logistics and supply chain expense will be regarded as “value add” and the manufacturers, distributors and retailers will get tax credit for such services availed. This makes development of warehouses in newer hubs away from prime urban localities an attractive proposition. Large land parcels are available at competitive rates 15 to 30 kms from urban boundaries. The capex incurred in land aggregation can now be limited to about INR 6 to 12 million per acre. The aggregation of large land parcels however needs some expertise but certain niche players and fund houses such as ours have demonstrated their track record in doing so and can be relied upon to close transactions with agility.

Other important factors for selecting a warehouse include quality and ability of the developer to deliver customized specifications. The advent of institutional funding backed companies in sectors such as e-commerce, FMCG, 3PLs and machine tools and their foray into manufacturing and trade has led to demand for quality and consistency all over. The warehouse developers that cater to these high standards are able to forge long lasting relationships.

The higher specifications requirement means that organized and established vendors are now part of the development process of warehouses. This has resulted in greater transparency in the whole process, which is working in favor of institutional investors and institutional end users alike. Corporate developers backed by institutional capital will find more takers than individual standalone land lords.

What sort of returns can an investor expect from a warehousing investment?

Warehouse as an asset class offers natural downside protection to the capital since demand is increasing and established warehouse locations will always be the first to get absorbed . Another factor contributing to stability in yields is that institutional end users and large third party logistics companies are more inclined to offer longer leases. These tenants generally bear fairly large amounts of capex for establishing their consolidated warehousing hubs and distribution centers.

With high quality tenants signing up long term leases, the business offers stabilized yields over investment horizons of four to six years. With standard escalations it is safe to assume that 8% to 11% entry yields will consistently grow to 12% to 14% over four to six years.

Importantly, warehouse development offers the inherent upside of land value appreciation. With warehouses continuing to be developed on the borders of urban areas, and industrial and urban footprint increasing over the years, the present day warehouse locations will see multifold appreciation in capital values of underlying land. In the past, our own investments have seen such capital appreciation over five to six years on account of our logistics parks being included under newly formed urban centers. As a combination of growing average yields of 10% to 13% and capital appreciation of 5% to 7 % per annum, it is possible to achieve ROIs of 18% to 20% over five to seven years of investment cycle.

How is Milestone looking to leverage this story?

The future definitely looks promising for warehousing as an asset class and hence we should be seeing institutional players such as Milestone participate actively in this space. Going forward, we shall continue to grow our exposure in this asset class. Given the success of our earlier ventures, Milestone has chalked out details for a niche warehousing focused fund and has begun lining up investments, which will not only offer downside protected high yield opportunity but also allow exit options through a REIT of the portfolio in future.

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