E-tailers may not - yet - provide the largest occupier base for logistics developers, but it’s certainly the fastest growing and sure looks like one of the most exciting, reports Robin Marriott.
In Mönchengladbach, Germany, Zalando’s facility blows the mind. In this day and age of automation and robotics, it is a surprise to find 2,500 people working at this order fulfilment centre for Europe’s largest pure-play fashion e-tailer. And it is about as far removed as one can get from what British industrial agents still call ‘sheds’, because the inside of this facility couldn’t really be described as a traditional shed of four walls, a roof and a forklift truck. Instead, inside there is around €150 mln worth of bespoke facilities not only for picking, sorting, and packing but also for the staff.
Zalando is of course part of a trend of continuing penetration of e-commerce in the global economy that is creating huge demand for logistics warehousing whether the e-tailer occupies the facility and pays the rent itself or whether that is done by a 3PL – an outsourced provider and manager on behalf of the e-commerce company.
In talking to various logistics developers, it is easy to see why the etailing segment of the logistics market captures so much attention. Firstly, e-commerce is unquestionably a young, growth market. It has come a long way fast. One has to remember that it was only in the mid-2000s that management teams at some of the largest and best known industrial developers were turning away Amazon, so sceptical were they of a company that hadn’t turned a profit. Today, Amazon occupies something like 20 million square feet of logistics property in Europe.
Such rapid growth has led to the online retail industry in Europe generating around €600 bn of sales in 2017, according to the E-commerce Foundation, up 14% on the previous year. Unsurprisingly, Amazon came top in a list compiled in 2015 by Fung Global Retail and Technology which based its findings on five key metrics, revenue being one of them. The US giant was followed by German fashion group Zalando mentioned earlier, John Lewis, Yoox Net-A-Porter, Cdiscount/Groupe Casino, Next, Apple, Metro Group, ASOS and Ocado. The pure-play online retailers on the list (those that have no or very few physical stores) such as Zalando and Yoox Net-A-Porter, made €7.8 bn of sales between them in that year and the tribe of such internet-only groups saw year-on-year online growth range from 16% to 40%.
Where logistics property development fits into this is obvious: as e-commerce grows, so does demand for a developed network of order fulfilment centres and other types of logistics hubs. It is a pattern being seen all over the region that began in Northern and Central Europe and has spread more recently to Southern and Eastern Europe as online penetration deepens in those regions.
Ekaterina Avdonina, managing director of Delin Capital Asset Management which specialises in European logistics real estate, is one of many who confirms the ‘transformational’ demand in the sector. ‘That is why everyone is so excited about the opportunity,’ she says.
Delin manages 800,000 m2 of stock and has a development pipeline of 500,000 m2. ‘We constantly analyse the source of that demand and our portfolio is 100% in line with European averages. In our portfolio, 30% of occupiers are pure-play retailers and e-commerce players. Let’s not forget that eurozone economies are performing well so we have a lot of demand from traditional occupiers which is also growing, but what has been most exciting is that 30% of total demand is coming from e-commerce needs, a number which we expect to keep growing. We have seen an astronomical boom in occupier take-up for all forms of facility in Europe.’
By way of example, the company has just delivered a 60,000 m2 facility in Roosendaal, the Netherlands, for Lidl Digital, the online arm of the eponymous German retailer. The facility fulfils non-food orders around the Greater Benelux region and northern France. Around 1,500 people work there and it contains everything you would expect by way of facilities from mezzanine levels and automation to locker rooms and social areas for staff.
Design and location
E-tailers have very particular needs that are different to traditional occupiers of logistics facilities. They employ anywhere between 1,500 to 3,000 people so need to be located close to large labour supplies, and they require a high level of space optimisation, power, plus physically large sites.
One of the most striking and obvious ways in which retailers are altering the landscape of logistics is that buildings are getting larger, and in particular taller, as James Markby, managing director of Logistics Capital Partners (LCP) explains. LCP is a privately owned developer and asset manager which set up three years ago as a challenger company to the bigger and longer-established logistics developers, but has been punching above its weight by winning various tenders from the likes of Amazon and Primark. It has secured a pipeline of projects in France, Spain, the Netherlands and Italy.
Also in Roosendaal, LCP has developed a distribution centre for Primark 20 metres high with large structural mezzanine levels, which then has an automated garment handling system. Most standard flexible warehouse buildings are 10 – 12 metres in height, or 15 metres if there is to be an optimised racking system. But this facility required extra permitting to allow for the extra height to accommodate the mezzanine floor and garment handling system needed by the fashion retailer. ‘We are definitely seeing a trend towards higher and higher buildings,’ says Markby. ‘That could be extra mezzanine levels or real multi-storey logistics properties with robots inside - as we are developing in Italy. There are different ways of optimising and maximising height / cubic capacity in buildings – there are different solutions to the same challenges.’
He notes that as consumers demand lower costs and faster delivery times, this is impacting on retailers who need warehouses that can process higher volumes, which requires optimisation of heights, cubic capacity, and operations. For example, it means not only centralising and combining inventory in strategic locations, but also significantly increasing areas for picking, packing and handling returns and inventory, and then accommodating all the people and vehicles needed to do this. In a typical e-commerce building half the space is now devoted to processing and operations, not storage. That alone doubles the size of a traditional warehouse. It’s a natural evolution.
It is the developer that tends to shoulder the financial risk involved in a development, not the occupier or retailer. The risks and challenges increase in the case of a retailer seeking an unusually tall building because finding a zone permitting 20 metres in height is tricky. Fifteen years ago, no one anticipated a 20-metre-high logistics facility might be required.
The danger for an occupier is that it can go through a whole site search and tender process thinking there is a lot of seemingly available land, but with height restrictions and zoning there might ultimately only be one site that can take a 20-metre building and is ready to go within their required timescales. Or there is a risk of say 6-12 months of additional time necessary to work it through the planning system, which doesn’t sit well with a retailer’s board that is trying to service possibly hundreds of stores that have recently been opened. Obtaining a licence can take months to prepare in tandem with multiple regulatory bodies. It can often take 24 months from the time a board decision is taken to invest in a new facility to taking occupancy.
Raimund Paetzmann, former head of Amazon European real estate and now vice president of corporate real estate at Zalando, knows more than most about the risks and challenges. It is his job to help this pure-play etailer continue to grow rapidly by developing the logistics network to support €4.5 bn of sales which are predicted to continue to grow by 20–25%.
Online fashion is a particularly difficult product to plan ahead, he remarks. At the same time, there is a gap in knowledge among the logistics developer community in terms of what etailers need, However, Paetzmann adds: ‘There has been a lot of improvement in recent years. The property industry generally is still one of the most customer-averse in the world. Sometimes, developers are developing for their investors, and they are not really thinking about the occupier. What we expect is to be able to really talk to a developer that really understands our needs.’
E-tailers are turning the traditional landlord/occupier relationship on its head because the occupier will dictate the design of the building it needs and then seek offers from the development world. The developer will be more like a ‘facilitator’ and a rental agreement will often be signed prior to the land being acquired. Despite wanting total transparency from potential developers in terms of their costs and profit margins and therefore the rent to be paid, the search itself is kept quiet. An etailer will not publicise widely a search requirement for fear of losing competitive edge and the danger of costs in a target area suddenly rising. In an ideal world, a proactive speculative developer would approach it with an interesting solution having understood what the etailer‘s future needs are, but that is yet to happen in Zalando’s case.
Clever design is the answer to avoiding obsolescence
E-commerce occupiers might want to dictate designs to developers, but this can also create a difficult balance as investors are ultimately investing in a building and land which may not have the same residual value or be readily turned back into traditional storage facilities.
The answer for developer-landlords tackling this issue is clever design. For example, some etailers require structural / concrete mezzanine levels for picking, but the technology exists to create mezzanine levels that can be more easily folded away or deconstructed for a more traditional end-user. ‘We see a lot of new flexible design solutions that can accommodate both developers, occupiers and future landlords,’ says Delin’s Avdonina.
When it comes to such occupiers, given the huge investments they are making and average length of occupancy, the question of obsolescence becomes less of a concern. Avdonina: ‘Typically, an ecommerce company invests between €50 mln and €100 mln in optimising its space complete with robotics, automation, and the specific technology required for each facility. Factor in the wage bill at around €15-30 mln annually, and the investment can easily top €150 mln. That is a bigger commitment than build costs of €50 mln-100 mln. In other words, etailers can invest a sum in a building that is three times the value of the building. Occupation therefore is a long- term decision.’
Ten years ago, logistics buildings only needed to be located by a motorway crossing, but for e-tailers they need to be nearer to metropolitan areas to be closer to customers and labour sources. Also, just because the trend is towards denser buildings, it doesn’t mean the overall land size can be smaller. For a property of say 1.3 million square feet, an e-tailer will require a total footprint of around 2.5 million square feet to accommodate trucks and their turning circles plus large numbers of car parking spaces for workers. It is frankly a myth that e-commerce facilities do not need many people. In fact, logistics facilities now need around 40,000 square feet just for offices and social areas for all the people. Fire regulations also create the need for certain spaces. Given this need for space and a sufficiently large, close by population, there are not a huge number of appropriate sites to pick and choose from. This is another reason why they are unlikely to vacate without very compelling reasons.
LCP’s Markby argues there are layers of ‘mitigating factors’ that all stack up to counter the obsolescence point, which has been concerning investors since the inception of larger scale buildings in the early 2000s. ‘We of course think about obsolescence, but I am not convinced that it needs to be any more than any other asset class or sub-sector of the logistics world,’ he says. His points include the fact that there is large ongoing necessity and growing demand for buildings. These larger and multilevel warehouses are not short-term contract buildings, they are absolutely fundamental to an occupier’s revenue, growth, future success and profitability.
‘Occupiers are investing huge sums in each building that can generate over €1 bn of revenue and the cost and headache of moving is enormous.’ If alterations are required, the responsive landlord will continue to offer them, working with the occupier to continue to enhance the efficiency of the building, thus removing a need to move. Thoughtful design solutions afford the ability to convert buildings. Furthermore, there is an argument that because of yield compression, rents have been kept low. However, as costs rise and yields potentially rise there will be upwards pressure on rental levels. Says Markby: ‘The current vintage of buildings is going to look like some of the lowest rented buildings in the future. Trying to replicate that is going to be a big challenge.’
This is still a relatively young industry, and this issue of potential obsolescence is yet to be played out, In the meantime, many e-tailers continue to evolve their requirements, and logistics developers must respond. Right now, new formats are being developed and each completed one creates further demand for associated facilities in a ripple effect.
This is why there is exponential growth. However, developers also know that not all e-tailers will succeed. They have noticed how a host of e-commerce companies have got into trouble and disappeared over the last two years. As Michael Hughes, founder of Verdion and former co-owner of Helios Properties, puts it: ‘There will be winners and losers in this game. Just as the high street has seen some failures, the same will be true of e-commerce. When you look at operators working in various market sectors, some will run out of cash and expand faster than their ability to infill and create new business and others will be huge successes.’