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Logistics property resilience: the road to nowhere?

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Why future-proofing your expanding property requirements is probably a waste of time. David Thame explains.

Nobody is opposed to resilience. Who in their right mind would be in favour of the alternative: being unprepared, exposed and in needless danger? The trouble is that resilience in the logistics property market takes two forms. One is fairly easy to accomplish, the other almost impossible.

The easy win is to future-proof new warehouses from the point of view of energy costs and sustainability. Although nobody can predict the price of power in the years ahead, warehouse users (as well as their landlords and developer partners) can do a lot to mitigate the risks.

Developers now routinely aim for BREEAM standards of good and excellent, which demonstrate high environmental and sustainability targets have been met. They also include a suite of goodies, from rainwater harvesting through to photo-voltaic arrays. Three or four years ago, these would be regarded as extras – and expensive extras at that. Today, they are standard.

The difficulty comes if a distributor or retailer wants to ensure that if they need more floorspace they can have it. At a time when e-commerce is still expanding fast, but the supply of new warehouse floorspace is growing more slowly, getting hold of extra floorspace becomes harder every day. Whether it is to meet seasonal surges or satisfy plans for long-term expansion, resilience demands flexibility – and flexibility is the one thing the property market just can’t deliver (for now).

If the property market is a problem, then so is the mind-set of many warehouse users. The obstacle to resilience is internal, not external, because these firms prioritise efficiency over resilience. The more efficient you are, the leaner you are, meaning the less slack you have to cope with surges in demand or changes in businesses patterns.

Lean, cost-effective businesses do not burden themselves with just-in-case leases or expensive land purchases. And if this is how your business thinks, resilience is probably a non–issue. When more floorspace is needed the only option is to plunge into the property market and take your chances. Good luck with that, it could be expensive.

That said, there are various approaches available to retailers and 3PLs. Some work some of the time, some work almost none of the time, and several barely work at all.

So what to do?

Here’s SHD’s rating of six common approaches, from the hits to the misses and the wastes of time.

A large empty warehouse

Choose tall warehouses ☆☆☆☆☆

The logic is impeccable: the higher the eaves, the more cubic capacity; opening the prospect of inserting mezzanine floors that could double, or, in really tall warehouses, triple floorspace. Most occupiers are already thinking about cubic capacity, and it is an obvious and fairly easy win.

Warehouses with 10m to 12.5m eaves are unlikely to make a good prospect: its not impossible but it’s not obviously easy to fit in a mezzanine. Warehouses from 15-17.5 metres make a much better bet. “If you’re lucky you could get 50-60% more floorspace capacity without really paying for it,” says Colliers' Head of Logistics Property, Len Rosso. The downside is that rising construction costs could screw up the maths in marginal cases. But this one gets five stars – it's worth a try.

Take an option on a plot next door ☆☆☆

Pets at Home are understood to be one of several occupiers to go down this route. In 2020, they signed up for 670,000 sq ft at Stafford North Business Park, just off the A34. Work on site is now underway and it should be ready for occupation in late 2023, but in case the firm needs more, it has agreed an option on further land with developer Stoford. The deal would allow a further 100,000 sq ft, should it be needed.

The details of the Stafford deal are not known, but generally a developer will want something like a rent for the unbuilt building. Say it was a five acre site (about what you need for 100,000 sq ft), then that adds up to about 225,000 sq ft of land, so guess at about £1 a sq ft (it might go as high as £2) and back-of-the-envelope calculations suggest its going to cost about £225,000 a year. Which is a lot.

Alas, mostly this kind of option deal doesn’t work. “It does happen, it can happen, but the interests of the occupier and the developer are difficult to marry up,” says Len Rosso.

Wrinkles include the difficulty faced by developers trying to sell a warehouse to investors if it includes a plot with an option, because it complicates pricing and risk. Developers will be thinking that five good, well located acres might have cost them £5m, and that they could make about £1m more or less now (20% profit on the land price) by simply building 100,000 sq ft and letting it to someone else at £7/£8 a sq ft. So why bother?

There’s also a risk for occupiers. Rent of £225,000 a year becomes £1m before you know it. That’s cash that could have been helping your business, rather than used to speculate on future property requirements.

“When options get mentioned what you get is a massive negotiation and generally it doesn’t happen. The occupier just decides to acquire another building in five years’ time, if it needs it, and generally they don’t know whether they will need it,” Rosso explains.

The lower risk version is to seek a right of refusal on next door (see below).

A logistics property being constructed beside a pre-existing warehouse and a motorway

Rent more logistics property and hope ☆☆

This sounds daft but actually happens under the fancy name of “merchant facilities.” The idea is that 3PLs are so confident that they will get a contract or contracts that they sign up for floorspace anyway. If the operational deals they hope for do not materialise, they could sub-let the warehouse and mitigate the loss (or maybe make a profit). It’s all a bit risky, hence “merchant.”

Buy some land and wait until you need it ☆☆☆

The most resilient approach possible and one favoured by discount grocers Lidl and Aldi. This method has the upside of providing them with a guarantee of new floorspace if and when they need it, important in the high pressure world of grocery. But it is an expensive option since land in a useable location connected to the motorway network is not cheap: think £1m an acre, or higher. On the other hand, if you have cash to burn, or can borrow cheaply, it could turn out to be money spinner: in a rising land market today’s buy for £1m an acre could be tomorrow’s sale for £2m an acre, if you decided not to build. So, swings and roundabouts.

Buy some green field land and take a gamble

There’s a riskier variant of the Lidl/Aldi approach: buying strategic land. The expression “strategic land” is a bit slippery, because “strategic” here means almost exactly the opposite – it means uncertain land, probably in the green belt or without a link road or infrastructure. The idea is you secure options to the land in the hope that, one day, it will get planning permission and become valuable or useable. It is strategy in the sense of being a monumental gamble.

Strategic land is cheaper than consented land, but comes with the obvious risk that you fail to get planning permission. And if you do get consent after three, four or five years of effort, the landowner you bought the option on will demand a hefty payment. These kinds of deals have varying terms, but assume that 80-90% of the market value of the land has to be paid to the landowner once you get consent. Looking at the figures, many firms conclude it's not worth the bother.

Seek a right of first refusal ☆☆☆

A low risk approach to resilience, but possibly also with a low chance of success.

The idea is to go to the developers behind one of the big logistics sites – Magna Park, DIRFT, Lutterworth – and sign up for your fancy new warehouse on the usual terms. However, as part of the negotiation, insist on the right of first refusal on the unit next door. Developers will probably agree – and bingo, you have resilience.

The downside is that in a super-hot logistics market the right of first refusal may turn out to be of limited value. The illusion of resilience may be painfully short-lived.

“This is a buoyant market and it may only be a couple of weeks before the developer has a potential taker for the unit next door, at which point you will be asked to exercise your right of refusal – and that’s the end of the story,” Len Rosso explains.

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