Bond spreads do not (yet) capture high energy efficiency at logistic real estate issuers.
Logistic real estate generally has a lower carbon footprint than retail real estate, though disclosure of energy performance (and carbon emission) is lagging at various EUR IG logistic real estate names. Although Prologis and PELF stand out in terms of energy performance, this is not (yet) visible in their bond pricing.
Logistic real estate has a lower carbon footprint than retail real estate
However, investors and tenants of logistic real estate are demanding higher energy efficiency
Disclosure of energy performance (and carbon emission) is lagging at various EUR IG logistic real estate names
Although Prologis and PELF stand out in terms of energy performance, this is not (yet) visible in their bond pricing
Logistic real estate as an asset has been rallying extensively over the past few years due to a general lack of available properties and strong outlook for growth in e-commerce. But the ESG bid could have also played a role: as shown on the chart on the left below, the carbon footprint per item is much lower compared to when this good is sold through traditional shops or through the internet.
Real estate advisor, broker and investor company JLL issued their EMEA 2023 outlook recently. On the logistics real estate sub-sector JLL specifically called for a ‘growing emphasis on future-proof buildings’ and it was even willing to assert that non-ESG compliant buildings are ‘at risk of becoming functionally obsolete’ as tenants and investors become more aware about energy efficiency. This could perhaps drive a higher bid for logistic real estate companies with lower energy usage credentials.
Given the swath of green bond issuance from this sub-sector where the proceeds are tied to high quality building labels, the low average age of properties and the issuer’s strategy to emphasize energy efficiency in the development process, we presume that holdings of highly inefficient properties will not be material. Indeed, when comparing the average carbon emissions of Prologis or Segro against the emissions by various office real estate issuers, it does not seem that there is a big gap. This comes despite logistics properties being subject to higher energy intensity due to, for example, their open spaces and in many cases also (light) manufacturing taking place in the buildings.
However, it is important to compare the average energy performances amongst the EUR IG logistic providers. When an issuer has properties that have lower energy usage vs the competitor, their properties could attract a higher interest from tenants and investors. Equally, the issuer’s bonds should trade at tighter credit spreads, after adjusting for other items such as issuer leverage. For simplicity we assume the average energy performance we use does not entail large variability across the issuer’s total portfolio and that the energy efficient properties are also located in desirable locations. Regarding the latter, we note that for example both Prologis European Fund and Segro have a gross rental yield close to 3%, which are in line with the low 3% recorded for prime logistics properties in Germany, France and the UK (source: Colliers).
Some issuers are still lagging in terms of energy and carbon disclosures
There are ‘only’ 8 logistic real estate issuers where each has more than 3 bonds outstanding to justify analyst dedication. However, 3 out of these issuers in this small universe still lag when it comes to energy and carbon emission reporting, including downstream scope 3 energy usage and carbon emissions. This scope 3 tenant data is key as it shows energy usage when actually being used for the purpose for which it was designed. Indeed, for issuers that do report own usage and tenant data, own emissions only represent a small part of energy and emissions. The 3 issuers that lack tenant energy and emissions data are Blackstone Property Partners Europe (BEP), Logicor and CTP. In the case of BEP and Logicor, one would assume that the backing by US property behemoth Blackstone would have positive impacts in terms of disclosure. CTP is actually an issuer which has printed its entire 8 Euro bond stack in green “use of proceeds” bond format. One would have assumed that the CTP green bond investor might have shown interest in actual energy and carbon performance data when the bonds were printed, than just purely relying on property labels. This does not seem to be the case.
Prologis (and PELF) stand out in terms of low energy usage
As such there are 5 issuers which provide better disclosure than the issuers above, being Prologis, Prologis European Logistics Fund, Segro, Segro European Logistics Partnership and VGP. The table below shows the latest operational emissions (i.e. including tenant) and energy usage per square meter per annum (psqm pa) as taken from the issuers’ sustainability disclosures.
Prologis properties apparently are lowest in emissions and energy use. The difference to the other issuers is quite large as well (nearly 50% less energy used in comparison to SELP, for example). We have combined the picture for Prologis and PELF as the parent company reports emission data comprehensively across is affiliates, including its ventures such as Prologis European Logistics Fund (PELF). We are comfortable to use the Prologis data, which includes Americas, Europe and Asia, for European focussed PELF. The higher emission factor on electricity in Europe would actually entail a lower energy usage when converting carbon emissions to an implied energy usage, hence energy usage might even turn out to be lower at PELF level.
Prologis’ best energy performance does not seem to be priced in
As our goal is to assess to what extent bond investors are pricing in property energy efficiency, we leave out VGP from the assessment for recent significant spread volatility, but also as VGP has a development & sell model and the comparison to the pure play real estate issuers becomes difficult. The remaining issuers operate at different credit ratings, but also different leverage and the chart below on the left shows their near-term leverage outlooks according to the rating agencies.
We use these leverage outlooks to standardize the spread being offered at the moment on the issuers’ bond to achieve a better like-for like comparison. The chart on the right above shows this leverage-standardized-issuer-spread for various durations. Hence, Prologis and PELF bonds look rather cheap considering their superior energy performance, also considering that at least all the PELF bonds shown are in green format. We would presume that high energy efficiency would rank high after issuer leverage as a driver behind spreads, as it reflects the desirability of the underlying properties (and hence also a stronger ability to service debt). It seems however that the bond investors are not yet taking this into consideration.