Deutsche Finance International has entered into a joint venture with UK diversified real estate investment company Argo Real Estate to build a UK urban logistics platform to the tune of £400 million ($513 million; €469 million) in asset value, PERE can reveal.

The venture has been seeded with 11 existing assets across London, the South East and Manchester acquired through two separate portfolio transactions, covering approximately 1 million square feet in total area. The first deal closed in May and comprised six assets purchased from Tesco Pension Investment for £95 million, PERE understands. The remaining five assets were acquired from London-based flexible workspace owner-operator Workspace Group for £82 million in June.

These acquisitions mark the first foray into the logistics and industrial market for London-based private equity real estate firm DFI, which manages €3.9 billion in assets and is an affiliate of Munich-headquartered investment management firm Deutsche Finance Group.

“We’ve been looking at the sector for the last three or four years, having liked the occupational fundamentals around it,” explains DFI co-founder and chief investment officer, Gavin Neilan. “But, given we are value-add/opportunistic investors looking for high-teen returns, and there was so much liquidity in the market, we were effectively priced out.”

RoccoGrande and Neilan: began looking at UK logistics after the market started to reprice

The situation changed quickly toward the back end of last year, says Neilan, driven by the impact of the war in Ukraine and persistent rate rises. He felt the UK, and the logistics sector within that, would likely reprice the fastest given the liquidity that had entered the market and the tight yields in the space. “We started to believe it would be a very interesting entry point for us to invest into high-quality single assets and portfolios through off-market transactions and special situations.”

While the firm had not previously worked with London-based Argo Real Estate, DFI co-founder and head of capital markets, Frank RoccoGrande, tells PERE it had built a relationship with Argo over the past two years. “They’ve been successful in the past and have a very high-quality team that is extremely knowledgeable in the sector. We began looking at things together as the market started to reprice.”

Notable among Argo’s activities in the logistics sector is the sale of a £180 million portfolio of urban warehouses to Blackstone-owned UK developer St Modwen in November 2021.

RoccoGrande explains that Argo is leading on asset management in the venture, Argo DFI Logistics Partnership, and has a meaningful minority investment alongside DFI. He declined to disclose exact details of the split.

The capital will come from DFI’s European Value-Add Fund II – which launched in 2020 targeting $500 million, per PERE data – in addition to DFI’s related co-investment partners.

In focusing on UK urban logistics, the JV hopes to take advantage of a structural undersupply of industrial and logistics space in prime locations, with a net loss of more than 60 million square feet of industrial space to alternative uses in inner and outer London over the last 20 years, says Neilan. This is being exacerbated by construction cost inflation and increases in interest rates making it more difficult to develop. “Alongside that there are very strong secular drivers of demand, including e-commerce and the requirement for space in the right places to be able to deliver very efficient last mile,” he explains.

Call for capex

Of the 11 assets already acquired by the venture, 10 are leased, with an average occupancy in the portfolio of over 90 percent. Although the one unleased asset is the only one in the portfolio thus far requiring “material development,” Neilan says the strategy for all current and future acquisitions is to capture rent reversion, enhance the user experience and improve sustainability criteria.

To achieve this, DFI and Argo have committed more than £30 million in capex to focus on driving efficiencies for the end user. This can include upgrading the lighting, insulation and electrification, which could involve installing solar panels on the roof of some assets.

“There is increasing evidence of a green premium emerging in the industrial sector,” says Neilan. “We think it’s going to be increasingly important for tenants, as well as potentially creating a two-tier investment market where you have green versus brown yields.”

This conviction underpins the strategy to add value to assets during a hold period of 3-6 years. The venture plans to deploy the remaining capital in the next 12-18 months.

Neilan says he has seen some liquidity return to the market since the seed portfolios were secured last year, in particular via UK funds coming back into the market, but observes this has slowed amid recent rate rises and continued concern with inflation in the UK. “Overall, we continue to see opportunities of assets priced at interesting levels that require some element of value-add.”