PL

Demand to grow despite the virus

Economy
Rising inventory levels, the boom in e-commerce and the diversification of manufacturing locations could all translate into higher warehouse demand across Europe despite the economic risks posed by the coronavirus pandemic.

Prologis has been carrying out a series of surveys since the start of pandemic on the implications of Covid-19 for logistics real estate. The studies have been conducted by Prologis’ dedicated research department, which studies fundamental and investment trends to assist clients in identifying opportunities and avoiding risk across four continents. One of the conclusions from these surveys is that despite the risks posed by coronavirus to economic growth, there are three areas of change, which together may translate into higher levels of warehouse demand. These include rising inventory levels (as companies tend to strengthen their supply chains in uncertain times), the continued adoption of e-commerce, along with the diversification of manufacturing locations.

Inventories on the rise

Supply chains generally try to minimise their inventories so that they can distribute goods at lower costs. They hate volatility, as this leads to lost sales and revenues. In the past, events such as natural disasters and work stoppages at ports have led to step changes in inventory practices. In the wake of Covid-19, companies are likely to reassess ideal inventory volumes and business continuity plans, which could translate into greater demand for warehousing space. Many firms are likely to build higher inventory levels to ensure the resilience of their supply chains. Several tenant segments stand out for having very lean supply chains at present, including food & beverage, electronics and appliances, healthcare, and diversified retail. In the ‘new normal’, the demand for logistics real estate created by a reassessment of ideal inventory levels could be concentrated in industries that held minimal buffer stock pre-Covid.

Building up additional inventory is manageable for all firms and relatively easy to implement. In addition, carrying costs will remain low given the record-low interest rates. Prologis projects there will be 5–10 pct inventory growth, which would produce additional space needs of around 25–50 mln sqm in Europe – if the US estimate of each 100 basis point of growth in inventories generating over 5 mln sqm of additional logistics demand also holds true on the old continent.

Prologis expects this shift to lead to broad-based logistics real estate demand growth, with an emphasis on large consumer populations, access to transportation and modern facilities. Prologis’ assets in Europe are located in key logistics hubs in the markets with the largest consumption, which it believes will prove to be most resilient in an economic downturn. Prologis expects to see outperformance in Europe from its stay-at-home economy customers, led by the food & beverage sector, which was a key driver of the increase in short-term leases during the first weeks of the lockdown. The vast majority of Prologis’ clients in Europe have remained open for business and even during the peak of the outbreak in March/April, 95 pct were still open.

E-commerce accelerating growth

The current expansion of the warehouse sector has been driven by the emergence of online shopping, which grew by 16.7 pct globally in 2019. Covid-19 doesn’t seem likely to change any of this. Instead, it may increase the speed of it and the number of consumers who shop online. Given the advantages e-commerce had during the lockdown, this form of retail might take on even greater importance when it comes to the basic functioning of everyday life – especially in the hardest-hit markets.

E-commerce accounted for 40 pct of new leasing activity during March and April, significantly higher than the 20 pct seen pre-Covid. Based on historic demand statistics, the Prologis Research department has quantified this for Europe where e-commerce penetration levels today average 11 pct. Every 100 basis points of additional e-commerce adoption could translate into almost 2 mln sqm of incremental logistics real estate demand.

According to the 2019 data, e-commerce requires more than three times the logistics space needed for brick-and-mortar sales. This persistently high ratio will generate the need for additional e-fulfilment space should the gains in e-commerce penetration made during the lockdown be maintained.

Faster e-commerce adoption should require greater supply chain investment from low-penetration industries such as groceries. Several tenant segments are still in the early phases of e-commerce adoption, including food & beverage, construction and home improvement. These industries have relatively small e-fulfilment operations, and re-tooling supply chains will require substantial real estate investment. Third-party logistics specialists could benefit from this shift. Industries such as diversified retail and electronics have much more established e-fulfilment operations but still enjoy high sales growth. E-fulfilment demand should be highest in locations closest to end-consumers, such as city logistics properties.

As Dirk Sosef, Prologis’ European vice-president for research and strategy, explains: “While the latest research focuses on the US markets, now that societies are reopening across Europe similar demand trends can be observed as in the US. E-fulfilment supply chains needed to keep pace with the continued double-digit online sales growth across Europe. This growth was a trend pre-Covid-19 and the pandemic has only accelerated this across the region, pulling forward several years of adoption. As in the US, we have seen an increase in defaulted retailers, but the diverse demand across the region continues to support resilience.”

Manufacturing locations diversify

Covid-19 could accelerate another structural trend: pushing manufacturing to new locations. Aided by industry 4.0 trends that boost productivity, manufacturers have been evolving their global supply chain strategies by increasingly emphasising near-adjacent locations alongside reshoring. Strategies that focus on the consumption-end of supply chains will not be affected by these trends. While production-end locations alone are not a major investment strategy, this broadening of manufacturers creates second-order demand through both suppliers and networks that serve blossoming consumer markets.

Planning for future disruption could gradually push many industries towards a greater diversity of manufacturing locations, including on- and near-shoring. While the production process generates much less logistics demand than the consumption-end of supply chains, shifting production locations could create new consumption centres that will need to be serviced by logistics real estate tenants across many industry segments. Low-cost production locations such as Central and Eastern Europe are beginning to see increased interest. These changes are likely to be a long-term trend that plays out over several years.

Logistics well positioned for the long run

Looking across all real estate property types, the performance will follow on from how tenants adapt in this environment – for example, office users and their adoption of telecommuting versus coworking. For logistics real estate, momentum continues to build for new structural drivers to play a role in the medium and long term.

According to Prologis Research, logistics is also well positioned to weather changes in the real estate capital markets. While long-term leases can counter such disruption, capital flows may slow due to financial market volatility and the subsequent denominator effect. And yet tempering forces do exist. Investors have been under-allocated in real estate, especially logistics real estate. Interest rates have fallen and are likely to remain low. In terms of the fundamentals, logistics on the whole is better positioned than other sectors, given the potential boost to long-term demand from inventories and e-commerce. Capital is also likely to favour core assets in strong locations, prompting a flight-to-quality.

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