The young guns of the new EuropeWarehouse locations
Rafał Ostrowski, ‘Eurobuild Central & Eastern Europe’: You have just completed a study of the top 100 industrial locations in Europe. How did the Central European region perform in this ranking?
Dirk Sosef, vice-president, research and strategy, Prologis Europe: We are continuing to see the rise of the CEE markets – they are becoming more and more interesting for warehouse users. The top ranked CEE locations are mainly located in Poland. This is something we previously noted in our 2015 survey, but it is a trend that has been maintained. Central Poland (Łódź) is now the fourth most attractive location in Europe. This is the best ranking Central Poland has ever had in our surveys. Kraków is also highly ranked and closes the European top ten. When you look at the top 25 locations, three of them are in Poland, as Wrocław is also there, while two others are located in Romania and one is Prague.
What were their main strong and weak points?
CEE markets particularly dominate the European ranking when it comes to location drivers related to low costs, such as the cost of labour and real estate prices. But, on the other hand, they continue to underperform compared to the rest of Europe, on the criteria connected to infrastructure and the proximity to consumers and suppliers. I think once all the infrastructural improvements are in place and economic networks are better connected, more locations in the CEE region are expected to move up in the overall rankings.
What would you say was special about the CEE market?
The key thing that comes to my mind is that it is a relatively young market. In fact, it is the youngest logistics market in Europe – we only saw its emergence in the early 2000s, when the Schengen treaties were incorporated into EU law and the European open market was born. It is also rapidly growing. When you look, for instance, at the existing logistics space in the region in the last ten years, it has tripled. This means logistics space consists mostly of modern product. In Western Europe there are still many warehouses from the 70s and the 80s.
Why is the CEE logistics sector growing so fast?
There are two main growth drivers. Firstly, the CEE region is the fastest growing economy in Europe, and with this growth we are seeing the emergence of a middle class. This is also driving consumption, so you can see that retailers need space for their operations and, especially, for their growing online sales. The second driver is the final assembly. The parts are assembled in the CEE region and then the completed products are distributed across Europe. What is really important with final assembly is that there is a great deal of labour involved and a lot of value-add logistics services. You can see that in the warehouses – where there is not only a storage of goods, but also much activity and added value to the product, which is typical for this region. One of the reasons why we are seeing this stronger focus on value-add logisticsservices has to do with the relativelylower labour costs compared to Western Europe.
How resilient are we to the economic cycle?
The CEE market is still immature relative to the rest of Europe, but it has strong fundamentals. For example, the vacancy levels in Bratislava or Prague are among the lowest in Europe. What is also characteristic for the entire CEE region is that it bounced back quite strongly from the global financial crisis. Budapest is one of the best examples of this. Just four years ago its vacancy was the highest in Europe and the market conditions were quite tough. We have seen, however, a strong recovery since then and now the vacancy in Budapest is roughly in line with the European average of around 5.5 pct and net effective rents are already undergoing quite a strong recovery. That ability to recover is something that is true of most CEE markets.
What about Poland? We haven’t seen rent growth on this market for a long time.
In Poland the picture is slightly different. Rents have not recovered in the same way as, for instance, in Budapest – and net effective rents, that is, the headline rents minus incentives, are still among the lowest of all developed economies in the world. Sometimes effective rent levels are well below the economic rent required to develop new product, something that is quite frequently connected to the market’s lack of transparency.
Why is that?
This is driven by two main factors. One is the strong development competition, with certain submarkets offering excessive incentive packages. And the other is the declining cap rates and lower return requirements, which have resulted in lower replacement cost rents, that is, the rent required to warrant new development. From a global perspective, net effective rents in Poland are now the lowest of all developed economies but are expected to grow in the short to medium term as a result of favourable operating fundamentals and increasing replacement values.
This was an issue that was engaging Polish market specialists and players a couple of years back. Some insisted that developers are weakening the market with incentives, while the investors who are buying product cannot earn enough. Do you agree with this view?
Yes, there was indeed a time when the situation was unsustainable, but now the market is gradually becoming more transparent and investors are making wiser decisions. There now exist some interesting entry points on the market, because net effective rents are so low and they should rise as the current rents are unsustainably low in a market environment with favourable market fundamentals. I believe that there are now many opportunities in Poland. I would say that this market is reaching a tipping point and it could be one of the big performers in the next few years in terms of rental growth. Poland has strong market fundamentals with vacancy below historic benchmarks and it is the largest and most liquid market in the CEE region. And since investors are attaining a better understanding of it, we could expect it to move in a positive direction.
How important is the influence of political factors for the warehousing market? And how do your tenants respond to them?
In general politics is less important than people might think. Overall, logistics is quite a resilient asset class. It tends to be rather impervious to economic or political shocks because logistics operators focus on long-term growth. Of course, you have to put this into a certain perspective. What happened in Turkey and Russiain the last few years really shook those markets. Those were events that impacted the overall economy and all the real estate sectors, including warehousing.
Warehousing is still expected to be revolutionised by robotics. Do you feel that this already happening – and does your study point to this?
In general, robotics is playing a role in how and where warehouse users operate. But this change is gradual; robotics is not something that has been adopted on a large scale. It tends to be the largest tenants, specifically active in e-commerce, who are especially embracing it. So generally it is mostly humans who are still doing the work in warehouses.
Why is it not having a major impact?
Well, you could write a whole book on that one. But first of all, it requires substantial investment in something that is changing rapidly. As with computers, you buy one and the next day it can already be out-of-date, because technology becomes obsolete very quickly. So some customers say that they would rather have a more efficient and flexible supply chain than heavy investment in robotics. Another thing is that logistics, and particularly warehousing, is not always easy to automate. This has to do with the variety of the products and different peak times inside the warehouses, For instance, car manufacturing is relatively easier to automate because the procedures carried out by the robots – such as welding the cars, for instance – are more or less the same; whereas in logistics you always have different sizes to deal with, different picking and packing, and so it is not always easy to automate the process.
What are the main changes taking place on the logistics real estate market right now? And what does the survey reveal about this?
The key change is the revival of the southern European markets. In the same way that Budapest recovered a couple of years ago, we are now seeing markets like northern Italy bouncing back.
It seems that we have a very strong market across Europe at the moment. How long will the good times last? Does your survey give us any indications?
No. The study doesn’t really cover that, but we would actually need a crystal ball to say for how long the new investment will continue to flow in. There are two things I can say, however. Firstly, the United States is about three years ahead of us in terms of logistics market growth. So if you compare the US cycle to Europe’s, we still have time to grow further. Secondly, if you think about European growth, ours is really being driven by supply chain reconfiguration. So the demand has a structural driver, rather than it being economic expansion that is driving the growth.
What role is consolidation playing in this process?
When you consolidate into one or two central locations, instead of having, for example, ten different locations and ten different driving routes, you generally have a much more efficient supply chain. This is playing a part in the structural reconfiguration we are seeing now.
Where are Europe’s logistics hotpots of the future likely to be?
These will be markets that are well connected to economic networks, customers and suppliers, and those with competent, available and qualified staff.