In a tenants' market, shed developers need to listen to the client

19 July 2010

The sluggish logistics occupier market in Europe showed tentative signs of improvement during the first half of this year. The underlying figures, however, suggest that the market is far from a recovery in rents and take-up.

The market is being propped up mainly by demand from retailers trading consumer goods and commerce, according to Danny Peeters, chief executive continental Europe at Australian property trust Goodman.

"Sentiment has improved since the beginning of the year, but we are still far away from the enquiry levels seen in 2006-07," he says, adding that Goodman is seeing demand recovering in France followed by Germany and more enquiries in prime locations in eastern Europe. But Spain is lagging behind. Mike Hughes, head of specialist European logistics developer Helios Europe, has also been encouraged by signs of better times ahead. "In the past eight weeks, there has been a resurgence in occupier demand from the third-party logistics outfits in our core Western central markets - France, Germany, Poland, the Czech Republic and Austria," says Hughes.

Hughes says that the increase in enquiries is for space ranging between 5,000 m² and 50,000 m² and is the result of manufacturers and retailers resolving to make decisions on property. "To some extent, occupiers in the logistics sector are counter-cyclical," he says. “When the economy is suffering it is time to improve the supply chain in order to improve margins. They are now looking at improving their property and outsourcing to 3PLs to achieve greater efficiency."

Despite these encouraging signs, the most recent figures make for grim reading both in terms of takeup and rents. Take-up in the main European warehousing markets amounted to 10.1m m² in 2009 an annual drop of 27%, according to Jones Lang LaSalle.

These historically low figures have continued to depress rents in the first half of 2010. In its May European Property Indicator report, King Sturge noted that 11 logistics centres had registered a drop in industrial rents during the first quarter. Even Paris, where rents for large industrial units remained relatively untouched during 2009, registered close to a 4% fall to €50 per m² a year.

Other cities in which landlords struggled to maintain rents include Dublin, Milan and Madrid. The main centres in central Europe also suffered a decline in rental levels. Budapest's rents fell by close to 9% to €38 per m² in the first quarter. The Czech Republic and Poland also continue to experience sluggish occupier markets, with rents in Prague and Warsaw adjusting to €54 per m² and €40 per m² respectively. In the face of such doom and gloom, the question has been whether the increased power that tenants wield at the negotiating table will lead to an overhaul in building design and lease terms. It is something that the heavyweight occupiers have been lobbying for in recent months.

Paul Graham, development director at DHL Supply Chain, is evangelical about the need for developers and investors to work harder to provide the space that occupiers require. "State of the art, environmentally friendly and operationally efficient logistics facilities should be valued differently," Graham says. "All parts of the real estate industry should be closely considering what goes on inside a building and how it performs. There should be intelligent valuations from valuers and funds that reflect all relevant factors and not just location, length of lease and covenant strength. "Also, we as the logistics industry have to get smarter about how we position and sell such buildings to our external customers as part of our total logistics solution."

The issue was recently discussed at a CBRE conference just outside Paris. Investors, developers and occupiers, including DHL’s Graham, talked about the requirements for industrial space. Guy Frampton, executive director at CBRE, says that five principal trends emerged at the conference. First is the need for improvements to buildings, or intelligent building. Second, there is a preference for more flexible leases. Third, sustainability is important - essentially, the debate suggested that although occupiers and the big developers are pushing this agenda, the funds have not yet quite got to grips with its implications. Fourth, benchmarked evidence is needed for investors to show that a building more intelligently designed is indeed more cost effective. Fifth is the add-ons that service developers can provide for third-party logistics and occupiers.

Goodman's Peeters reckons that there is a better balance between occupiers and developers. 'Twelve months ago, when there was more product available in the market, if you were up against landlords with existing vacant stock offering huge incentives, it was challenging," he says.

He adds: "At the beginning of the year, the biggest issue was the length of lease, with occupiers seeking three to five years and investors stipulating at least 10 years. But since then investors and occupiers have moved towards a position where five-year terms are now acceptable on both sides."

Richard Holberton, head of research at CBRE, says that the UK market is increasingly seen as too inflexible. "The longer and less tenant-friendly leases typical in the UK are regarded as a particular hindrance in an environment where flexibility is so highly prized," he says. "Whether or not it is formally specified in lease terms, the experience in continental Europe is that investors are significantly more involved in issues such as maintenance, rather than offloading the responsibility to tenants." Holberton quotes one major occupier at CBRE'a conference, saying: 'We should push for a standardised approach to tenant-friendly leases. Our business is making things, not fixing sprinklers."

Built into this attempt at improving give and take is a feeling that developers and institutions should be able better to deliver the product occupiers want. "Intelligent building" is the buzz word.

DHL's Paul Graham is not alone in suggesting that although occupiers and the larger developers such as Gazeley and ProLogis are moving in the same direction, there is still some way to go for the institutions. The key issue remains a lack of clear benchmarks to establish that modern and sustainable facilities will eventually prove to be cost effective despite the increased build cost. To this end, DHL is coming out of a sizeable warehouse in the UK, although it will not confirm the location, and taking up occupancy of a nearby purpose-built facility where it intends to provide factual evidence of the cost savings of 'intelligent buildings”.

“Rent is only one variable to total occupancy cost and we shouldn't get bogged down in that factor alone," says DHL's Graham. 'In the past, occupiers have been seduced by low, competitive rents without an analysis of the true costs. We should be looking at the total value proposition, including sensible green features, which are cost effective with relatively short pay-back periods and reduced long-term obsolescence.

With advances in technology, the value proposition associated with green solutions and reduced carbon footprint now exists. However, there seems reluctance in certain areas of the real estate industry, particularly among fund managers and investors, to recognise this. Green buildings may cost marginally more to construct, but the argument for such investment in terms of payback and reduced obsolescence is compelling. It is time for the industry to listen to the occupier."

One area where there appears to be real change is a greater focus on developers and institutions providing ongoing services and facilities management for occupiers.

James Markby, EMEA logistics director at CBRE, says: "Because of the importance of tenant retention, there is a move towards outsourcing services, and funds are focused on a joint-due proposition." (Source: EuroProperty - 19.07.2010)