It’s a young old world

Rafał Ostrowski, ‘Eurobuild CEE’: It’s an exciting time for warehousing now with all the figures rising and a booming market. What do you personally find interesting in the latest data and trends?

Dirk Sosef, the head of Prologis’ research and strategy in Europe: There are a couple of things I’m excited about. I mean, the structural changes to the logistics sector that are now taking place. First, the market is maturing. I often use the fairy tale comparison of the ugly duckling turning into a beautiful swan. We are moving away from a niche market to a really important real estate sector, which more people understand and find attractive.

Why exactly is this happening?

For lots of reasons – for instance, e-commerce. Online retailers are intensive users of logistics space. In line with the growth of online sales, we are seeing a lot of demand growth from online retailers. And that’s happening all over Europe, including the CEE region. In general, when you look over the longer term the e-commerce market in the region has been lagging a bit, but it is now catching up quite rapidly. We are seeing that both in online sales and in the demand for warehouse space. The latter is already picking up rapidly in the region. When we look at our own portfolio, which we do each quarter, roughly 20 pct of our new leasing is by e-commerce players. Five to seven years ago it was only 5 pct. So you can see how big this change is – and it’s another thing about the logistics sector today that gets me excited. The third has to do with changes to supply chains. When we look at the behaviour of logistics space occupiers, we see them very much focused on the consumption-end of the supply chain – that is, close to the point where the product reaches the consumer. We are seeing a lot of activity there and that’s where Prologis wants to be. It’s where most of the growth will happen in the long term. The fourth thing to be excited about – and this is almost a summary of all the previous points – is that investors are really very interested in logistics real estate.

All of these would seem to give grounds for optimism over the future of the logistics market...

What makes the case for a long-term investment strategy even stronger is that the European logistics market is still under-supplied. We have an average of 2.5 sqm of logistics space for a consumer household. In the US it is 7.5 sqm, three times more. Why is that? Because we are still a very young logistics market. As I mentioned at the beginning, we are maturing; we are not a child anymore, but we are still a teenager. And I think that the CEE market is a very good example of this. Around the year 2000 there was hardly any logistics stock in the CEE region. In fact, there was only a very rough sketch of a market 15 years ago. And look where we now are today. So we are catching up rapidly to reach normal levels of logistics.

Well, it’s quite obvious that the CEE region is a young market, but it’s rather surprising you think of Western Europe almost the same way.

It obviously depends on which market you are comparing it to. If you compare Western Europe to the CEE region, it is more mature, but when you compare it to the US, it is still a relatively young market.

But why compare it to the US? These markets might be totally different.

Firstly, both economies are rather similar in size. That makes their markets comparable. Although the US is the most developed market in the world, it can serve as a good indicator of where our own market is headed, so I like this comparison. Of course, one has to bear in mind the differences in terms of the wealth and the geography. Despite that, three times more logistics space is still a big difference. But what you can see – and I think this is also an interesting observation – is that the European market is catching up with their levels of warehousing stock. That applies to both to the CEE region and the rest of Europe.

How fast is it catching up?

We have carried out some research that shows that since 2006 the European economy grew by 15 pct, but its stock of occupied logistics grew by 80 pct. You can see how rapidly it is growing.

If you were to name just one thing that has changed in the logistics market in the last decade. What would that be?

I would say, its maturity. We are not a child anymore – but we are still a teenager. And the second word that comes to mind when I think only of the last three years is ‘scarcity’: the scarcity of investment product, the scarcity of available space, the low vacancy, the scarcity of land, the scarcity of construction companies, the scarcity of labour – that has been the main theme for the last three years.

It’s now a developers’ market across Europe, isn’t it?

The tenants’ market has turned into a landlords’ market because there is less product available. Think of Budapest, for example. Around 2007 it had a lot of speculative product and so during the crisis it took quite a big hit. The vacancy levels were at one time above 20 pct – among the highest in the world, so this, for sure, was a tenants’ market. What we have seen in the last two and a half years is a revival in sentiment among occupiers. There were hardly any new developments, so all the demand coming from tenants was really focused on the existing stock. We saw vacancy levels plunge. Now they are below 5 pct. So this shows you how much the market has changed, not only in Budapest, but in the vast majority of European markets.

And why is this change still occurring?

Europe is in a period of expansion. The vacancy rate at the pan-European level stands at around 5.2 pct today. That’s the lowest level we have ever seen. It is even below the levels we saw back in 2007. And vacancy rates continue to decline. Why? Because first of all there is strong demand from occupiers; and secondly, the new supply is much more disciplined, meaning less speculative and more thoughtful. It is focused on build-to-suit – and it’s not like it’s being led by just volume, volume, volume. In 2007 it was quite the opposite. I need to mention, however, that speculative product is not a bad thing in itself, but you need to do it in a smart way – in locations where there is the demand. And I believe we saw a lot of projects in 2007 in markets where this didn’t make any sense. So the market is much more disciplined now and we are seeing rising rents too.

How fast have they been growing?

On average, effective rents have been growing by roughly 3–4 pct per year. This is the average of many different markets and these differences often have to do with the rent cycle. So, on average, net effective rents are 5 pct below their prior peak – the last high point, which for many markets occurred in 2006 and 2007. However, there are significant differences between markets. In the UK and in Northern Europe net effective rents are above the last highest point, but for the CEE region they are still significantly below it – by roughly 15 pct, so the rents in CEE markets on average are still very depressed. And with these low rents in today’s market environment of high demand and low vacancies, you should expect rents to rise rapidly. And this is what we have already been seeing.

The lowest rents are in Poland – why is this and how much lower are they?

There are big differences across different markets, but we could say that on average rents in Poland are about three times lower than in Western Europe, meaning net effective rents in Poland are now the lowest of all the developed economies in the world. For a number of reasons this is now changing rapidly: of course, the economic conditions in Poland and across the whole of Europe are good, but for the logistics market there are much more important structural reasons. These include depressed rents – and since we are below the prior peak, there is still a lot of growth ahead of us; there’s the low vacancy rate; we have a landlords’ market; there is hardly any available product; and, importantly, the construction costs required for developing a warehouse are rising rapidly, so when a developer wants to have a building for the long term it’s necessary to include these higher costs in the rent. This applies to any developer across the globe, and the CEE region is no exception.

In your latest study you focus on the structural differences between industrial locations across Europe. How could that classification help investors to identify investment opportunities?

What we are seeing is that the differences between local markets are being driven by the different roles each of them plays in the logistics supply chain. These are structural differences. For instance, the southern part of the Netherlands is a very important hub for pan-European logistics. The structure of that market, the type of customers, the size of the buildings, the kinds of locations, are all different to, let’s say, a big city like Madrid. Madrid is not a market that is focused on pan-European distribution. It is one that is focused on consumption. So when you look at that logistics markets across Europe, you can see lots of differences. You may ask yourself how to group these markets. At Expo Real in Munich in October I will present a market classification that groups them.

So how do you categorise these different kinds of market?

You can think about four different market types across Europe. The first group are ‘global gateways’, which are the biggest markets in Europe, such as London and Paris. These markets are subject to a great deal of diversity in demand. The second group are the ‘critical supply chain links’. These markets serve a broader distribution area and are really focused on pan-European distribution. They include, for example, the southern Netherlands and Silesia. The third group are the ‘consumption markets’, like Madrid, Rome and Warsaw. The demand in those markets is really driven by consumption, so many retailers are active in them. The fourth group are the ‘regional hubs’, and when you look at these different regional hubs they always serve high growth economies such as, for example, Budapest. That was a really brief introduction to the structural differences we see across markets. I believe that when, as an investor, you better understand these differences between markets, you can then identify the best investment opportunities.

If you were to give one bit of advice to an investor interested in the logistics market today, what would this be?

First of all – and this is kind of strategic advice: understand the long-term demand of the users of logistics real estate. If you understand your customers, you can really accommodate the demand.

And what is the most common location strategy that tenants have right now?

Principally, the strategy of our customers is to deliver a high-quality service at the lowest possible cost. That is their key strategy. How can they do that? The trick is to really focus on the best locations. Why? Because warehouse rents are generally only a small part of the total supply chain costs. These customers spend most of their money on transportation costs, while the warehouse rent itself is a much lower expense in the total supply chain. So when you, as a logistics user, have a building in one of the prime locations, although you could be paying a slightly higher rent, you would still be saving a lot of money in terms of the total cost.

Any other advice you might give to investors?

My second piece of advice would be that you need to team up with the right partner, one that has its boots firmly on the ground. A partner who really understands the local specifics, because the differences across Europe are significant.

If there is going to be one big game-changer – that is, the most significant factor over the next ten years – what would it be?

I would say professionalisation. This also includes innovating in terms of smarter ways to design buildings, so that they are more sustainable for instance. But it also applies to how data is handled. There is vast amount of data available that can be used to give crucial indications on the way the market is going. So when the market professionalises, you should be getting even better insights from this data. You will be able to make decisions based on the data and not on your gut-feeling. This is also what I mean by professionalisation. ν

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