Realignment of corporate supply chains will eventually lead to greater occupier activity and investor appetite, writes Alexandra Tornow

Logistics has moved up the corporate agenda over recent years. Companies seek to implement best practice logistics management to reduce costs, enhance revenues and drive competitive advantage. On the back of globalisation, increasing supply-chain complexity, changes in the customer market, and increasing supply-chain risk have been the key drivers of network re-alignment. This, in turn, has contributed to the emergence of a new class of international-standard distribution facilities globally.

The pressure to re-examine supply chains, and therefore the network of logistics facilities that support them, remains high, in particular in times of low economic growth and uncertainty stemming from the euro-zone sovereign debt crisis. This pressure is reflected in the continuous high occupier demand for state-of-the art logistics and distribution facilities across Europe. Although take-up volumes were 20% lower in the first half of 2012 on the equivalent period last year, amounting to roughly
6m sq.m in H1 2012, they were still roughly 20% above the 10-year average as companies sought to reduce costs, compress time to market and develop new channels.

A recent inaugural survey of European-based supply chain professionals by Jones Lang LaSalle also reiterated the evidence of continuous pressure on supply chain managers. Indeed, the results of the survey confirmed that network re-alignment will continue unabated over the coming years. While this in itself was not a big surprise, what was noticeable was how two main issues emerged that dominate the agendas of supply chain professionals: cost pressure and multi-channel distribution.

Meanwhile, the survey also showed that rising energy and transport costs, changing consumer demand and transport infrastructure constraints were key challenges to an efficient supply chain.

Cost pressures, which are further heightened by the euro-zone sovereign debt crisis, are driven by increasing globalisation. Increased and volatile transport costs and the risk of supply-chain disruption have become a major concern for supply-chain professionals. Significant wage growth in first-generation, low-cost manufacturing destinations such as Eastern Europe and parts of Asia has also led to an erosion of the labour-cost advantages that previously existed. As a result, companies are reviewing their location strategies to reduce transport costs and mitigate risk.

Meanwhile, shifting consumer purchasing behaviour is putting retail companies under high pressure to differentiate offerings, manage shorter product lifecycles and improve speed to market, as well as a growing home delivery segment. Today’s distribution networks are, in many cases, not prepared to support the required multi-channel approach and therefore require a significant re-alignment process to remain competitive.

What is evident from responses is that long-term trends anticipated in the survey will have a significant impact on the logistics real estate market, in particular in terms of location strategies and building standards. It is clear is that there will be a gradual increase in demand for new types of facilities and locations, as anticipated shifts in the market start to take shape over the next few years. New types of physical distribution facilities will include smaller redistribution and fulfilment centres located at the fringes of larger cities and neighbourhood pick-up stations for home shopping. Large distribution warehouses at major ports, airports and intermodal sites will remain en vogue as well.

Indeed, demand for new types of facilities and locations is already evident in markets with more advanced online retail markets. For instance, leading online retailer Amazon has started to move closer to customers by implementation of smaller e-fulfilment centres in urban areas across the US and it will be only a matter of time before this strategy is mirrored in the leading European markets, especially in the UK and Germany.

Short-term occupier requirements

The required future realignment in global supply chains will continue to drive demand for state-of-the-art distribution facilities across Europe over the coming years. However, it is worth highlighting that persistent uncertain economic conditions and ramifications of the euro-zone sovereign debt crisis, which have led to weakening manufacturing output and slowing export growth over recent months, are likely to cause a re-evaluation of the anticipated real estate activities and, in certain cases, will prompt supply chain managers to temporarily postpone real estate decisions.

As a result, occupier demand is expected to become increasingly selective throughout the second half of 2012, with likely resilient demand levels in markets such as Germany, France, Poland and Russia, while smaller markets and those hit harder by the euro-zone sovereign debt crisis are expected to experience subdued activity over the short term.

This view is supported by 75% of supply chain managers stating they are largely satisfied with facilities currently occupied. This suggests that they feel under no immediate pressure to seek alternative solutions. Real estate relocation over the short term will, therefore, be undertaken only on the basis of a strong need to expand or reduce floor space, or supply chain realignment pressures that cannot be postponed due to competitiveness and financial considerations. Meanwhile, many lease expiries over the next few quarters are likely to lead to lease renewals, which will probably be agreed on a short-term basis to allow occupiers the flexibility of relocation once market conditions improve.

On the other hand, most survey respondents indicated they require new-build or modern floor space. This highlights the importance of operative efficiency to manage costs and reduce delivery times. As reflected in take-up statistics over the past few years, lower-grade space is scarcely considered, which supports Jones Lang LaSalle’s expectations of an increasing pace of obsolescence and, consequently, a further increase in older units remaining vacant over the next few years.

This view is also supported by the importance given to sustainability measures from supply chain professionals. As the significance of green product is moving up customers’ agendas, pressure to operate sustainable supply chains to gain competitive advantage is mounting. This pressure is reflected in the growing demand for environmental certification of logistics facilities over the last few quarters, with the number of warehouses having obtained certification in recent months significantly on the rise across Europe.

What was also evident in the survey was the priority given to flexible lease terms. More than 50% of respondents do not intend to engage in leases longer than five years. This highlights a significant discrepancy between developer and investor expectations, with the latter reluctant to sign short leases for new-build stock, particularly in the current uncertain economic environment. Further, driven by tight finance markets, most developers will not consider starting construction without a lease agreement for at least seven years.

With many European logistics hubs expected to face a shortage of readily available large modern logistics facilities by mid-2012 and development activity still concentrated on build-to-suit facilities, supply chain professionals will struggle to reach their declared goal of shorter lease terms for new build stock. As a result, they will either have to make a compromise in lease conditions, or they may consider temporarily moving to existing second-hand space until new speculative supply comes onto the market.

Emerging logistics hot spots
Change happening in retail markets, the manufacturing sector and demographics on a global scale will drive rising logistics activity in new markets, and there are a number of European markets that offer significant growth potential. According to Jones Lang LaSalle’s survey, these markets must offer a combination of key attributes to be considered as potentially interesting by supply chain professionals. On top of these attributes stand international connectivity, economic growth and political stability, followed by the infrastructure investments and large labour pools.

European-based supply-chain managers voted Turkey top of the list of emerging logistics markets for the next five years. Poland and Romania followed as the next single markets, while respondents attributed strong potential to Eastern Europe as a whole.

Turkey, in particular, offers all attributes required to become an emerging logistics market. Geographically, it bridges Europe, with Middle Eastern, Asian and African countries offering strong connectivity. The Turkish economy is growing strongly based on a stable political framework. There have been and still are significant investments in infrastructure; a large and young population base offers a huge labour pool that is increasingly well trained; domestic consumer spending is on the rise and foreign direct investment has picked up significantly over recent years.

Meanwhile, a number of recent reforms have made a positive impact, including improved transparency in the Turkish real estate market, as shown in Jones Lang LaSalle’s latest Real Estate Transparency index (June 2012). The growing retail market and increasing trade flows are also driving demand for more effective distribution. Strong growth in container traffic in the main seaports around Istanbul (Ambarli, Mersin, Izmir and Haydarpasa) is another driver for the Turkish logistics market.

Together they accounted for a total container throughput (that is, quantity passing through) of 4.5m TEU (20-foot equivalent units) in 2010, putting them on the level of Bremerhaven and Valencia (respectively ranked fourth and fifth in Europe). As a result, demand for international-style modern logistics facilities will increase significantly over the next few years, and this will lead to accelerating development of modern logistics space.

Continue to benefit from change

Changing market fundamentals and increasing quality of stock over the past decade have been key in transforming the sector into an established institutional investment class. Between 2004 and the first half of 2012, a total of €85bn was invested in European logistics and industrial assets, achieving a 7% share in volume terms, and 13% in the total number of transactions of the overall European commercial direct real estate market.

Investment markets over the past four years have been clearly affected by financial and economic woes but, overall, investors appreciate the sectors’ historically stable performance. As a result, an increasingly diverse group of investors, including many investing on an international basis, are pursuing opportunities in the sector. European logistics and industrial investment volumes peaked in 2006-07 at €16bn and €15bn, respectively.

Volumes dropped during the financial crisis but have since recovered, and in 2011 recorded the third highest volume (€9.9bn). During the first half of 2012, a total of €3.6bn were invested, roughly 20% less than during the equivalent period last year. This decline was driven mainly by a slow start to the year while activity made up some ground in Q2 2012 (up 56% quarter-on-quarter).

Evolution in the European logistics real estate market has led to a significant increase in investable stock over the last decade, with investment opportunities becoming more abundant in markets outside of mature Western European markets, leading to a spreading of investment activity in recent years. Nevertheless, the core Western European markets (the UK, Germany and France) continue to account for the lion’s share of investment activity, accounting for more than 60% of total investment volumes between 2004 and the first half of 2012.

Respectively, 16% and 9% of the total were invested in the Nordic states and Benelux countries during the same period. The remaining capital invested in logistics and industrial assets was almost equally split between CEE/Russia and southern Europe. However, what is evident is the increasing appetite for prime assets in the main CEE markets, in particular Poland, the Czech Republic and – lately – Russia.

The European logistics investment market faces investor caution and a shortage of prime product. While this will suppress investment volumes over the next few quarters, corporate supply chain realignment and growing logistics activity in emerging markets over the next few years will not only drive ongoing high occupier activity but also sustain significant investor appetite, as well as further geographic spread of investor activity.

Alexandra Tornow is associate director, EMEA logistics and industrial research at Jones Lang LaSalle