Short and bitter-sweet

Warehouse & industrial
The huge demand for warehouse space in Q1 and falling vacancy are bad omens for tenants looking for short-term contracts. We could be seeing fewer and fewer of them

Short-term contracts have become something of a fixture over the last few years. According to CBRE, over the last three quarters the total warehouse space in Poland leased for short periods of time (six months or less) constituted 11 pct of all contracts. For example, in the first quarter of this year warehouse tenants leased more than 70,000 sqm on a short term basis compared to the total of 640,000 sqm leased. However, the real amount is probably under-represented, since this data does not include most of the companies that do not report short-term contracts to the agencies that monitor the market. The boom in short-term contracts started during the downturn, when owners were looking for ways to tackle vacancy. “In 2008 or 2009 the vacancy rate came to a dozen or per cent of the total and tenant activity was very weak. Short term transactions were an additional cash injection. The demand for them was mostly due to tenants’ reluctance to take a risk on long-term obligations when the economic situation was so unstable,” explains Paweł Sapek, the country manager at Prologis responsible for Poland. Still, that was then and this is now. “Now when we are seeing an obvious bounce on the market and the vacancy rate is at a record low, around 5.6 pct, the situation has changed,” says Patrick Kurowski, the director of the warehouse and industrial department at CBRE in Poland. Warehouse owners are now turning away from agreeing to such contracts and often do not have the right sort of space in suitable locations to satisfy the demand for it.

Logistics firms take the lions share

According to CBRE, the most frequent short-term contracts are signed with logistics providers – 70 pct of such deals. This stems from the fact that the clients of logistics firms often have highly changeable needs when it comes to warehousing space. “As a consequence logistics companies require similar flexibility from facility owners,” explains Paweł Sapek. Thus they feel that offering short-term contracts gives a significant competitive advantage. “You cannot successfully service large logistics players offering long-term contracts only,” claims the head of Prologis in Poland.

The usefulness of such contracts is confirmed by Marek Tarnowski, the president of Warsaw-based Solid Logistics, which currently leases 120,000 sqm in Poland, around half of which is in short-term lease contracts. “We have reached a peak in short-term contracts at the moment. We usually need space for semi-annual periods and are currently leasing a few such areas near Poznań, a dozen or so thousand metres each, as well as a dozen or so which have 2,000–5,000 sqm a piece. We use literally every bit of space around Poznań offered by developers,” explains Marek Tarnowski. The owners of the warehouses the firm works with include Prologis, Panattoni and Logicor. Leasing warehouses on a short-time basis is also a kind of insurance for logistics firms in a recession, such as in 2009, when suddenly everybody reduced their warehouse reserves. “We have three-year lease periods as well as those with three-month and one-month periods of notice. This provides us with a great deal of flexibility. If things go badly we can reduce some of the space or change it into long-term contracts,” explains Marek
Tarnowski. Apart from logistics firms, other tenants interested in short-term contracts – but to a lesser degree, include retail and production companies (a dozen or so per cent each).

The importance of maintaining healthy relations with the tenant is often emphasised by warehouse owners. Even though such contracts constitute a marginal percentage for some developers, they often consent to these treating them as supplements of long-term contracts. “Potentially we can sign a contract shorter than three years and even contracts that satisfy clients’ seasonal needs, on the condition that we have a strategic relationship with them,” says Robert Dobrzycki, the managing partner responsible for Europe of Panattoni Europe. Similarly, P3 Logistic Parks also agrees to short-term leases, but the company mainly combines them with its strategic goals. “If a company has not operated on the Central and Eastern European market and has no experience of it, we offer a short-term contract that we treat as a kind of incubator. After the expiry of the short-term contract, the tenant usually then opts for a long-term lease,” says Piotr Bzowski, the leasing and development director of P3 Logistic Parks.

In 2012 Prologis created a separate ‘Lease Lite’ brand for such contracts. The warehouse owner’s intense activity in this field is possible thanks to the large warehouse area it holds – 4.1 mln sqm in Central and Eastern Europe and a vacancy rate of app. 7 pct (app. 271,000 sqm). This is more or less how much the company managed to lease on a short-term basis in the CEE region last year. App. 170,000 sqm was leased in Poland (out of 2.23 mln sqm of the entire area held by Prologis in the country). “However, the contracts were exclusively signed with regular and loyal clients of the company,” stresses Paweł Sapek. But are such contracts profitable? These figures are “confidential” – however, it can be assumed that in Poland the company generates at least a few percent of its revenue from short-term contracts for its shareholders.

Short term is not for everyone

Investors, on the other hand, view such contracts less favourably. “The investment market does not take such contracts into consideration. For example, for a lending bank short-term leases have no value whatsoever. It is also difficult to sell such a product,” explains Robert Dobrzycki. For a developer whose business model is based on the profit obtained from selling properties, short-term contracts mean lower profits from such transactions. This is why many developers, as well as investment funds, prefer not to bother with short-term leases. “Our minimum contract term is three years, but the majority are agreed for longer periods. Taking into consideration the leasing costs – such as the agency fees, the fit-out for tenants and the need to refresh the area – short-term leases and the higher rotation related to them results in a relatively low effective rent,” explains Aleksander Mokrzycki, the vice-president of BPH TFI.

So it is not surprising that short-term tenants do not have a very strong negotiating position when it comes to such contracts. They usually sign them at the base rates, without any of the financial bonuses common in long-term contracts. The space is not adapted to the tenant’s needs in terms of the furnishing of the social and office areas or other amenities. The tenant does not have a guaranteed lease period because the contract is usually extended from one month to another or with a two-month period of notice. And provided there is a better party interested in the space, the short-term tenant will generally have to look for a new location. This can be a problem for seasonal tenants. “A tenant expects to be provided with space for a period of 5–6 months with no possibility of the facility owner terminating the contract. Such a situation is of course impossible for an investor to accept,” says Piotr Bzowski.

Finally, tenants do not have the option of leasing an area for a short period of time in every location. Everything depends on the availability of space in a given region. “For example, in Slovakia and Hungary we do not have short-term offers at all. In Poland they are also not available on every market,” says Paweł Sapek. However, the situation is highly changeable because of significant reshuffling among short-term tenants. Tenants have a much better chance in facilities which have got into trouble, often located near old roads, far away from motorways. Sometimes this additional space temporarily rescues a tenant who is up against the wall because of production or import oversupply. Furthermore, small areas are vacated in existing facilities cyclically, as a result of reshuffling among long-term tenants. That is why even in good locations the occupancy rate rarely reaches the full 100 pct. “Only by combining short-term and long-term leases are developers able to fill their warehouses entirely,” says Marek Tarnowski. He also points out that a low vacancy rate will sooner or later encourage developers to greater speculative activity, which should increase the vacancy levels and help short-term tenants.

There will be noshortage ofoffers

Opinions on the future of short-term contracts in Poland are divided among developers. “Because the market is currently in its growth phase and the amount of space without tenants has been gradually decreasing, it should be expected that the number of short-term contracts will decline,” believes Piotr Bzowski. Robert Dobrzycki is of a similar opinion. He believes that the market is focused on institutional leases, i.e. long-term leases that guarantee finance for such properties. “Such leases are the cheapest and they are more convenient for tenants who want to secure a longer period of notice. Meanwhile, the investor and the bank expect a guarantee that the contract will not be terminated prematurely. It is these coinciding aims that are driving the growth in the importance of long-term contracts, in which the developer and the investor can offer good leasing conditions because of cheaper financing and the greater liquidity of the product,” explains Robert Dobrzycki. Meanwhile, property owners who permit a greater share of short-term contracts claim that everything depends on the business model. “For us the operating revenue from leasing is the most important factor, whereas for some developers it is the profit from the sale of properties. This is a different business philosophy. I am convinced that with the scale of the portfolio which we have today, even if we reach our goal of leasing around 95 pct we will always have some space that we will be able to make available on a short-term basis to our largest and most loyal clients,” believes Paweł Sapek.

How long is short?

The warehouse market does not have one commonly agreed definition for short-term contracts. For the investment market this is usually a contract that is shorter than three years. Agents and developers are often prepared to treat all contracts signed for a period shorter than 24, 12 or even six months as short-term. Many of these contracts are agreed just for a month, with an automatic month’s extension provided that neither party decides to terminate it. As a result, such contracts are repeatedly extended and could theoretically last forever.