Logistics went 3D a long time ago, it’s time our analysis caught up
The last decade has seen the logistics sector transformed as the growth in online retail has turned the sector from a business-to-business distributor of goods in bulk to one increasingly in direct contact with consumers, engaged in the high-frequency delivery of single, and often small, items.
This has had a knock-on effect in our real estate markets as retailers and logistics operators have engaged in a ‘space race’ to position themselves at the forefront of the market – not always profitably, it has to be said. Nevertheless, this realignment of the sector means it is now expected to see stronger rental value growth than the wider property market in the coming years, having historically been a bit of a laggard (see Figure 1).
To understand why logistics property has seen its investment characteristics do a 180° turn – confounding the previous received wisdom on achievable rental growth in the sector – we need to think about the structural change we have seen, and its impact on the economic utility (and hence achievable rents) of distribution warehouse/logistics units.
Traditionally, the distribution warehouse has been a fairly un-dynamic asset, operating in a very two-dimensional way. Namely, the velocity of goods entering and leaving them has been rather slow, a function of their mainly business-to-business role – resupplying stores – while only their floor areas have been fully utilised.
The first point, velocity, has come under considerable pressure as warehouses have had to react to a more dynamic, internet-driven retail market; increasingly pressuring them to interact with customers directly. This has been addressed to a degree: cross-docking, more efficient data-led inventory planning, mixed-load pallets and increased warehouse automation enabling goods to be processed faster, minimising the storage of goods (a low value economic activity).
However, the second point, the relatively two-dimensional nature of the asset, is only just starting to come into play. Why is this important? Because by utilising the full volume of a distribution warehouse, retailers are able to further increase the volume of goods passing through. Although you might argue that just-in-time logistics renders storage volume a moot point, you would be incorrect. There will always be a degree of storage time, even in our new dynamic logistics environment. And by increasing the quantity of space in a warehouse that is being used, we can increase the velocity of goods through the warehouse because it will be more likely to be carrying the correct stock at the correct time, and consequently better placed to ship the goods without delay.
The key to unlocking this cubic value is, of course, robotics. Storing goods high up in a warehouse makes things difficult for human staff; inevitably these goods prove slower to move into and out of the warehouse (a drag on our key metric: velocity). However, we appear to be on the cusp of a robotics revolution in warehouses. New robots or automated systems are entering the market at a pace at which it is hard to keep up, and which fully utilise the cubic volume of any leased warehouse space.
For example, at its 240,000 sq ft customer fulfilment centre in Andover, Hampshire, Ocado has installed a stacked mechanical-grid system known as the “Hive”, whereby automated robots operate across the top, in tandem, to pick goods from below. The robots moving above the grid are able to reach down through up to 20 layers of boxes. No doubt we will see this system develop, and widen in use, as Ocado seeks to use the technology to drive its own retail efficiencies and also that of its retail partners. And there is nothing to suggest the model cannot be picked up by the non-grocery sector.
In the non-grocery sector, SSI SCHAEFER has developed what it calls the 3D-MATRIX Solution, a mechanical storage and fulfilment solution laid out as a 3D grid, with vertical and horizontal movements automated and all of the stock, theoretically, equally accessible.
These solutions, automated in three dimensions, essentially open up the whole cubic volume of even the tallest warehouses. Moreover, they help to ensure that the warehouse space loses very little economic utility at increasing heights – as the product is almost equally accessible throughout.
Looking forward, we can reach a fairly simple conclusion: occupiers’ growing ability (capex notwithstanding) to utilise the airspace in their warehouses would suggest they are able to better shoulder the cost of increasing rents. Something particularly significant in a supply-constrained markets such as London.
For the surveying profession, this raises a dilemma: how to accurately appraise the usable space in warehouses?
The economic utility of two warehouses with the same floor area can be radically different depending on their height, rendering pounds-per-sq-ft comparisons misleading. However, it cannot be as simple as moving to pounds per cubic ft. In order for occupiers to take full advantage of cubic volume, considerable upfront capital investment is required. This means that some occupiers will view warehouse height as providing greater utility than others, depending on their ability to finance what amounts to a very expensive fit-out. We should not expect to see significant gaps in rent open up between standard height and taller warehouses; the process will be somewhat more incremental over time.
What we can expect, is that in areas where residual land values are very high (such as London), the gap between standard and taller warehouses will become larger, faster, given the relatively lower cost of capital expenditure in these areas. Moreover, the increasing incentive to engage in automation within warehouses inevitably means occupiers will want to be able to amortise the costs across longer leases – a fillip for an investment community desperately seeking long-term income security.
In 2015, our Property Futures I research hypothesised that we would see a trend towards longer leases on urban logistics sites to help cover rising capital expenditure costs; 65% of those investors surveyed as part of the work agreed. Given that worldwide warehousing and logistics robot unit shipments are forecast to increase from 40,000 in 2016 to 620,000 units annually by 2021, by the market intelligence group Tractica, our theory may become practice sooner than we thought.