Covid-19 has accentuated and accelerated many of the key drivers in the industrial and logistics markets. The way we live has been abruptly, and possibly permanently, changed as people have been forced into finding new ways to source goods and amenities. While this has been positive in some respects for logistics demand, many supply chains have been disrupted and all industrial tenants are going through a massive stress test on their business models. Specific tenant types have flourished, given the greater demand, with some even expanding their operations. But there will be clear winners and losers in a market that is exposed to intense pressures, and businesses are demonstrating wide variations in their ability to adapt.
Tenants with business models that carry a high probability of long-term relevance to the modern supply chain will be key for landlords
Investors should focus on industrial assets with both asset-specific and location-specific qualities. Tenants with business models that carry a high probability of long-term relevance to the modern supply chain will be key for landlords.
Resilience in the middle of a crisis
The effects of the virus will be substantial. There will be a massive global economic contraction, which is expected to represent roughly 7% of gross domestic product in 2020. This will inevitably hold back demand for industrial space. Indeed, it will hit some real estate sectors very hard in the short term.
However, a two-speed market has emerged. We believe that the biggest short-term negative impact will be on industrial estates, trade parks and some XXL ‘big box’-sized assets that are supplying retail stores. These asset types are vulnerable to weaker consumption, particularly in the event of a more severe and prolonged consumer recession.
The most resilient subsectors are fringe-city and urban logistics, which are closely tied to the phenomenal surge in demand for online retail. Some estimates suggest that online retail sales volumes have been catapulted five years into the future in the space of just a few months. The accelerated adoption rate of technology across all demographics is likely to spur the growth of ecommerce further.
Over the medium-to-long term, we expect the sector to perform well as it continues to benefit from structural trends. Demographic trends (urbanisation) and technological changes, in particular, are expected to boost overall demand for the movement of goods. As companies rethink their supply chain needs, we believe these are the possible factors that investors should consider.
Ecommerce and the growth in grocery home deliveries
New cohorts are adopting ecommerce for every-day purchases, particularly among older generations. Growing confidence and a familiarity with this form of retail is likely to accelerate the trend. This has particular implications for urban logistics properties and ‘mid-box’-sized fulfilment centres. There will be winners and losers in this area of logistics too. Big players, such as Amazon, are dominating sales and smaller platforms could be edged out through fierce competition.
Deglobalisation and ‘near-shoring’
For Europe and the US, the ‘re-shoring’ of manufacturing will accelerate in the wake of Covid-19. Anecdotal cases of manufacturers who are frustrated by a lack of component parts, serve to highlight the fragility and inefficiency of operating long-distance supply chains. The continual advance of technology is increasingly rendering labour cost arbitrage less important, while 3D printing allows greater flexibility in location. Asia, and specifically China, will not be much affected by this given the growth of domestic consumption.
The last few decades saw businesses prioritise the speed of delivery over the certainty of delivery. Increased inventory levels are required to shift this back into equilibrium. The pandemic has served as a reminder that long supply chains carry risks that inventories can dry up. Ensuring that complete sets of parts are always available could lead to much larger inventory stocking and a greater demand for logistics space. This additional demand is likely to be very cost-sensitive.
Environmental, social and governance, and employee welfare
Given the challenges for tenants to adapt and compete, landlords will need to be increasingly aligned in improving environmental and social impacts, particularly in relation to employee welfare. Labour will continue to be an important resource and staff retention is a key concern for tenants. With greater pressures, supporting tenants in a more operational model could become much more important.
For investors, the short-term disruption to tenants will be felt in the performance of some assets. Despite positive media attention, it is not a one-way bet. Major disruption to supply chains has affected some tenants’ ability to pay rent and concessions are being made in many cases.
However, the long-term outlook for the sector is more prosperous. Assets that can demonstrate resilience as part of modern supply chains should perform. Location will remain the core consideration. Urban logistics and ‘mid-box’-size assets in fringe city locations will remain relevant given their efficiency, flexibility, available power supply, labour supply and strong tenant demand. ‘Big box’-size assets in ‘windy field’ (less urban) locations could still suit some strategies, but they are more vulnerable to tenant risk in a rapidly changing sector.
Lastly, tenant quality and context need to be heavily scrutinised by investors to avoid tenant defaults and long void periods. With careful consideration of these aspects, investors should find good investments capable of delivering for the long term.