James Fitzgerald (JLL): The increasing sophistication of industrial tenants

Published: 07. 06. 2022
industrial tenants

At this point there’s almost no empty industrial space available space. Just how tight has it become, and where are you seeing it most drastically?

You can see stats like the vacancy rate is now sub-2% consistently for prime markets. But there are still many opportunities for build to suit, non-speculative development. Even in greater Prague, there are opportunities, but there’s a timeline associated with that — usually 9 to 12 months and it’s getting longer given material shortages. Vacancy is clearly tight in all major European cities, and that’s being reflected in Prague and Brno.

It all comes down to pricing. Is nailing down a final price between developers and their clients leading to a situation that could actually stop the production of new space?

Developers are warning us, saying ‘you need to be a lot faster; we can’t hold the price.’ But we haven’t actually materially seen any developer either pull the contract altogether because they can’t deliver. The worst-case scenario is that they just pushed the timing out by to give them more buffer by a couple of months or they’re just very open about pricing. They usually go more open book to show tenants pricing more transparently. These construction prices and the timelines have been reflected in the rents anyway. There’s still rental growth happening.

How has the way deals are concluded now changed?

Usually, you agree to a set of commercial terms that are heads of terms. In the past, pre-Covid, that would have been fixed and then there would have been a 3-to-6-month period where you would negotiate the lease. What we’re now seeing is that there’s a potential risk of those rental conditions changing before you get to a future lease agreement. So, the big tenants are having to go back to their boards for approval of changes made after the heads of terms are signed. Tenants are a lot more flexible now on leases. They’re really pushing faster than they did before.

We keep hearing about the potential for near shoring to act as a new source of demand. But can the market actually withstand any more demand? Is there even the capacity?

I think there is. Like, if you’re looking in Ostrava, it has a huge offering. Even in some of the regions around the Czech Republic there are big BTS opportunities. Tenants are now having to be a lot more strategic. They’re focusing a lot more at the front end, on location design, network design. I think that’s where the art and science of logistics is anyway.

When you say the network design, you mean the entire supply chain?

Yes, the entire supply chain. In the past, only the more sophisticated tenants spent a lot of time choosing the right location for a warehouse. That’s proliferating into other users now. Even smaller tenants are engaging third party consultants, JLL or other agents, to help them select the location. And it’s not based on real estate costs. It’s based on transport, labor, inventory and all these types of things.

What’s the impact of increased gas prices on location decisions, especially for 3PLs? They calculate down to the last kilometer how much a location costs and what it means for their overall prices. Are they assuming these high fuel prices are here to stay?

In the operations of the supply of logistics companies, more than 50% of the costs over the period that they’re operating that warehouse is transport. Rent’s only about 5% of that, when we’re talking about a typical distribution center. This is why network design becomes even more critical for location at the beginning of the process. So, are 3PL companies accounting for this? Yes. We’re not sure if it’s plateauing. But they’re spending a lot more time thinking about the location and trying to minimize the number of truck movements in and out.

Which I assume means there’s potentially even more price pressure for a market like Prague…

We’ve just been reviewing we’ve just been reviewing forecasts for the next 3-5 years. The prime rent at the moment for the Czech Republic is €6.50 per square meter. I still think that’s quite low. There are obviously only a few examples in a market where you’re seeing anything above €7. We don’t see any slowing of rental growth. Location is critical. And 3PL particularly with e-commerce, online groceries, consumer goods for any fast-moving consumer goods, they need to be close to population centers. The further they are away, the more it costs them.

Now, in JLL’s recent industrial report, you talk about the rise of human centric design. Since when do warehouse employers actually care about their employees?

Very good question. Obviously with labor shortages, we have conversations every day now with logistics companies and production companies — labor is the number one issue. It’s not just attracting labor. It’s also retaining labor. In these conversations we’re having, employers have realized that they are in competition with other employers. Not just financially, but the happiness [employees feel] when they come to work, whether they feel connected to the job and the environment they’re in. The industry is getting a lot better at quantifying things like the design of the space.

This was already very clear in the office sector, in terms of the location of where the office is, the well-being of the office, the indoor air quality, natural light, green walls, things like this. All of those soft features. It took a while for the office sector apply a return on cost in terms of retaining staff and happiness.

It’s sort of like a carbon tax in the sense that once you assign a cost to emitting carbon, it becomes something companies can monitor and try to reduce.

It just makes sense. You put a unit cost on turnover and retention and the benefit of that. So, there’s a cost, which is the stick, and the carrot is to retain someone. There’s no reason some of these offices within warehouses have to just be four walls. They can be inspiring places to work as well.

On the contrary: there are actually very good reasons for the offices not to be simply four walls, especially if it’s now understood to have an HR cost.

Exactly, because there’s a financial impediment to it. But also, with the pressure on prime rents, you may have to attract workers to a different location. If a logistics company or a production company was previously looking to be in greater Prague, but now, because of land constraints, they’re having to push out into Central Bohemia. They need a way to encourage their employees to go there. If the place is inspiring and it feels good to go there and they feel welcomed, there’s more of a likelihood they’re going to come.

Strange timing, isn’t it, since we’re talking about automation really taking over? How is it possible that employers are still so concerned about their workers when we’re seeing greater and greater ability to automate all?

I think there’s I think there’s a misconception around automation. Automation isn’t going to make everyone in a warehouse redundant anytime soon. We were already under significant labor pressure even prior to these new distribution centers and new warehouses coming online. The way I see it is that automation is providing different types of jobs. A lot of people who are in these automated warehouses are more white-collar workers: software engineers, all types of engineers, scientists. We still need the blue-collar workers because with things like sorting and picking, automation still has a long way to go. It could be decades until we’ve actually kind of made those types of jobs redundant.

So, the entire facility has to be on a higher level. It’s a sort of gentrification of warehouses.

It comes back to STEM: science, technology, engineering, maths. But then there’s also this element of creativity, you need to problem-solve. It comes back to this concept of human centric design and warehouses. You need to attract different types of people, different demographics of people. It’s not just going to be all men anymore. There’s going to be a lot more women in the workforce in these offices. And if we look at these automated warehouses from a real estate perspective, there’s a lot more of an office component.

Tell me some of the components that are important in terms of making it more attractive.

You’re now seeing all the major developers putting exercise equipment on site, walking trails, little trees and little forests around the warehouses. Even to some extent having gardens, vegetable gardens, beehives, so on your break you can go and engage with those things. But then inside the warehouse, indoor air quality, indoor air temperatures, natural light…these things are becoming a lot more important.

What’s cutting edge now? What’s the sort of coolest idea that sort of shows how far this idea is going?

I think my answer is going to be quite a non-sexy answer. I think what’s more interesting and cutting edge is when developers work more transparently upfront in the permitting process with local communities. I think that’s the big advantage. I totally understand that the permitting process in the Czech Republic is convoluted. It’s difficult, because at so many points in the process, people can object and people are naturally skeptical of developers. But this is a new opportunity for the more forward-thinking developers to think about how they engage with local villages and local mayors and local communities. It’s not just “I’m going to put in your solar panels, I’m going to put you in a new football field.” It’s more about, what actually is the social impact of my warehouse over 30 years? And “how can we work with you to make sure that you’ve got that the community is proud to have us there.” That it’s not just an eyesore. That requires a shift in transparency in the governance of developers being much more almost vulnerable to what they’re proposing.


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