A bigger boom in warehousing on the way? Part 1: Current demand and COVID-19
As the global economy reels from the effects of the COVID-19 pandemic, warehousing is proving to be remarkably resilient sector say industry experts
The first half of this year has been tumultuous for the global economy, as lockdowns attempting to halt the spread of the virus have effectively put wholesale sectors of the economy into hibernation. Supply chain businesses and operators have not been immune to this, seeing costs rise from the disruption and scrambling for solutions as demand patterns shift. Within this, however, warehousing has seen little let up in the demand for space, with a number of critical macro-trends being accelerated by the advent of coronavirus.
Already, before this crisis warehousing was seeing a considerable period of sustained growth, as both mega-tenants, such as Amazon, as well as smaller businesses, sought space closer to consumers and growth markets. This has led to an excellent run of new builds and take up of industrial space over the last five years.
Although this pre-crisis strength has been a useful buffer for the sector, the continued strength of warehousing in 2020 has been remarkable, undergirded by the acceleration of key trends as a result of the virus outbreak. Principal amongst these is the massive growth in e-commerce caused by the need to socially distance, which has put a premium on warehouse space.
We decided to take a deep dive with experts from across the sector to understand the dynamics in play and how 2020 is unfolding.
The sector has never been stronger
A resilient sector
According to Andrea Ferranti, Senior Analyst, Head of Industrial & Logistics Research at Colliers, “The sector has never been stronger.”
Even against the backdrop of “A huge increase in demand over the past four or five years,” there continues to be comparable demand in the market compared to the recent past says Ferranti.
Chris Caton, Senior Vice President, Global Head of Research at Prologis also sees the “The logistics real estate market environment” being “incredibly strong heading into this period of uncertainty.”
Since the end of March, we've seen fantastic resilience really in logistics sector, where we've had about 5 million square feet of lettings and approximately 20 deals happen across the UK
When it comes to “Market vacancy rates globally, we're in the low fours,” percentage wise, which “is about 300 basis points below the strongest point in the last cycle. So, vacancy rates in 2007-2008, globally in the US and in Europe, were kind of in the mid-sevens, that's that was kind of a normal market environment. And they got up to about 10% in the global financial crisis, and then they work their way all the way down to mid-fours in the United States, mid-threes across Europe. Japan has gotten, I believe in the two main markets of Tokyo and Osaka definitely somewhere under two and a half to 3%. China a bit higher, but that's a high growth market. So, just a really strong point in the environment, incredible momentum,” which is providing a sustained floor to rental and occupation rates.
“Since the end of March, we've seen fantastic resilience really in logistics sector, where we've had about 5 million square feet of lettings and approximately 20 deals happen across the UK,” says Len Rosso, Head of Industrial and Logistics, Colliers.
We’re already 14% above the average, and we've still got two to three weeks to go before the end of the first half of this year
Kevin Mofid, Head of Industrial Research at Savills notes similar market dynamics in their research and records. “At the moment, there has been 14.6 million square feet of warehouse space transacted this year, and the average for a first half of any year is, is 12.8 million square feet. We’re already 14% above the average, and we've still got two to three weeks to go before the end of the first half of this year.”
When COVID-19 broke, they “Were expecting two things to happen: We were expecting demand for warehouse space to fall, generally speaking, and we were also expecting there to be a flurry of short term transactions … because [companies] supply chains are so out of kilter and them just needing space for overflow or whatever it might be.” Positively, although they did see some of this short-term behaviour, it was “not to the extent that we thought it would. Among the 14.6 million square feet transacted so far, only 8.5% of that is what I would classify as short term…. Actually, most of the deals that have happened for new warehouse space this year have been long-term. It hasn't been derailed by what's going on, and online retailers are our driving it in the most part.”
We anticipate that the longer-term structural trends ... will remain intact and may even be strengthened by the crisis
Warehousing giant Segro is also seeing divergence between sectors but the strength of e-commerce helping to underpin overall demand. “The warehouse sector is generally holding up well in the crisis and whilst some traditional retail occupiers and those involved in supplying the hospitality and travel sectors are facing incredibly challenging times, online retailers are experiencing a surge in sales and this is fuelling demand for new space,” says company CEO David Sleath. “We anticipate that the longer-term structural trends – such as e-commerce growth, increased urbanisation and the need for data centres to support the digital economy - that have been driving occupier demand for high-quality, well located warehouse space will remain intact and may even be strengthened by the crisis.”
Boom and bust
Although there is a generally positive opinion around the demand for industrial space, particularly in these economically challenging times, it is not unanimously positive news, with some sectors struggling badly to shift inventory, even whilst others cannot keep up with the product flying off their shelves.
Peter Ward, CEO of the UK Warehousing Association warns that although the arrival of “Essential supplies during this period of lockdown means warehouses have been full but that doesn't necessarily mean profitable warehouses.”
We've put some of our staff onto furlough and during Q2 we’re seeing sales revenue drop by 20% here in our warehouse
For his members, 40% of revenue “Comes through pick pack, handling, value added services, and so on and so forth, and probably that's where the margin is as small as it is in the industry,” but stacks of inventory haven’t been moving out of warehouses, as some sectors have seen big falls in demand that “they haven’t been able to make up, even as new inventory arrives from overseas.”
For Kelvin Gingell, General Manager for Rhenus Corby, they are one of these businesses Ward is concerned about. “With us being a third party provider, we're not sort of limited to one particular market sector, so, we've been able to, I suppose, weather the storm a little bit, but it has a major impact on us overall over the last sort of two months. We've put some of our staff onto furlough and during Q2 we’re seeing sales revenue drop by 20% here in our warehouse,” although they are “starting to see a slight upturn in the last two weeks.”
This next quarter, June, July and August is going to be absolutely pivotal in terms of how many how many of those SMEs in the marketplace will actually survive this
Ward points out that “Retail’s effectively in hibernation. A number of retailers that just don't have any online business at all … so there was this tendency then for the supply chains to be backing up a little bit and the first danger sign was we were running at 90% capacity.” At one point the continued arrival of goods at one end of warehouses but the lack of trucks leaving from the other led the UKWA to warn that there were just weeks left before there was effectively no buffer in the UK warehouse market.
The cash crunch is highly sector-specific and most likely to effect smaller players who don’t have cash reserves. For example, “If you look at the part of the sector that's in food service, I mean, it's just on its knees. They've got stockpiles up in deep frozen stores that just cannot be delivered because there is no outlet for the consumption. Having had no logistics activity that's been revenue-earning now for what will be effectively two or three months, they are going to be starved of revenue and cash for two or three months.” Ward therefore believes “this next quarter, June, July and August is going to be absolutely pivotal in terms of how many how many of those Small-Medium Enterprises (SMEs) in the marketplace will actually survive this.”
“Something we've been cautious though on is the auto supply chains,” says Caton. “Auto have been struggling for a year more and there's just a lot of change happening in the auto industry. So, I think if you're looking for places that were a little bit cautious, we would look to auto.”
Mofid agrees that the automotive sector is seeing some weaknesses, as is the aerospace sector, which is leading them to watch whether “The demand from online retailers mitigate any fall in demand from other parts of the economy that aren't doing too well.”
We've seen a race to lease space for e-commerce to accommodate some of this growth
Currently it appears that this is the case, with Caton believing that the current trends bely a “permanent shift in terms of online shopping”. Rosso similarly believes that this a moment of “structural change”.
“As an economy we're going to order more online, and because we're going to order more online, I feel the logistics industry sector is not going to be immune to what's happening in economy, but I feel it's going to be far more resilient. What I mean by that is I don't see the crash happening,” thinks Rosso.
“In the US, about 11% of retail sales occurs online. In Europe, it's a bit higher, lifted by the UK and 13-14% in all cases. That number probably rose by three or four basis points [in the US] in the first half of the year,” notes Caton. “I think a lot of that's going to stick and supplies chains are not agile by their nature, right? These are five- and 10-year-long decisions. We've seen a race to lease space for e-commerce to accommodate some of this growth.”
The analysts also point to the grocery sector as one where there has been spectacular demand, boosted by the fact that supermarkets “Just weren't geared up for this,” says Ward, “they haven't got the infrastructure in place,” leading to a big need for space to account for the shortfall.
“Lots of research houses were thinking that the grocery sector online sales will never grow because people like going to the supermarket – we have these habits’” explains Ferranti. “People go and buy the milk and bread on a daily basis. They don't do really weekly shopping much anymore, but we've seen the grocery sector to be one of the best beneficiaries of this because some people that were never online, particularly the higher age cohort, now are discovering the benefit of it.” (See our article on e-commerce trends here for more on this topic).
Indeed, such is the level of demand, that the majority of experts we spoke to noted that supply constraints were in fact the main thing to watch in the space.
“The real challenge facing the industry is the lack of available space to provide warehouse and industrial facilities, which are in such demand,” says Sleath, with that demand coming mostly from e-commerce requirements. “For example, if you were to assume a ratio of 75,000 square metres for every €1 spent online, this indicates a need for an additional 16.7 million square metres of logistics facilities in Western Europe to cater for the growth in online retail over the next five years. Finding the land to meet this demand, especially in dense urban population centres will be a challenge.”
“Back in 2008, we had about 97 million square feet of extending stock available on the market for units hundred thousand square foot plus, now we are below 35 million square feet,” in the UK says Ferranti. "Really, there is very little supply and this will sustain or mitigate any falling of rent should the economy not bounce back in 2021.”
Mofid gives similar figures, with “around 37 million square feet vacant. Now, that gives you a vacancy rate of about 6.8%, which actually is pretty low by historical standards, and actually I can see that supply of warehousing becoming quite constrained over the next 12 months, because developers will find it harder to build at the moment because of the current situation.”
This is also something that Caton sees as “A lot of the builders are kind of shelving activities. They wait and see what's happening in the market environment,” leading to “potential for supply to continue to slow down pretty materially here and demand to come back real quick.”
This is an exceptional circumstance against the background of some of the biggest GDP drops ever put on records. “We're forecasting the vacancy levels to fall much, much, much quicker than we normally would,” in European markets says Mofid. “When vacancy levels fall rent, rents rise - that's supply and demand,” meaning this segment of the economy is in the position of “counter-cyclical rises in rents, and that we that we wouldn't expect otherwise.”
Stay tuned for part two next week for the long-term forecast for warehousing space. Keep up to date with all of our analysis, events and content by signing up to our newsletter here.