With the COVID-19 pandemic causing widespread disruption, it is striking as to how much it has impacted our everyday life and needs. It would not therefore be an overstatement to say that recent events have projected the logistics sector into the limelight.
From an e-commerce perspective, the statistics are eye-catching. Whilst online sales have been increasing year on year reaching 21% of all sales in 2019, Savills has recently reported a further surge, with online retail now accounting for 30% of all sales. It estimates that if e-commerce continues to grow at the current rate, a further 14.9m sq ft of new logistics and distribution space will be required this year alone in order to keep pace with demand. Even if that figure is somewhat speculative, by any measure it is clearly a lot of additional demand.
The shift is also likely to lead to a change in the way businesses operate and their need for space. Previous models based on “just in time” delivery may, at least in the short to mid-term, move to “just in case” delivery and in doing so put added strain on demand for last mile delivery hubs.
How is all of this demand going to be met?
As ever, where there is demand, the market will follow. According to reports this week, take-up for UK logistics warehouses has reached an all-time high of 21.9m sq ft, almost half of which is down to on-line retail (44%). There are already signs that the UK real estate industry is rapidly adapting to this changing demand profile. In a classic example of last mile logistics or “new retail” taking over the mantle of “old retail” it has been widely reported that Amazon is to take over and re-purpose a large Toys R Us store in Croydon. While that deal could perhaps be dismissed as a one-off pre-letting opportunity on the back of a sympathetic local planning policy, Amazon has also been involved in a deal which points to a more structural change in the market away from retail towards logistics. In another example, Pentavia Retail Park was at the end of 2019 a somewhat tired seven-unit retail park in Mill Hill, earmarked for a Build-to-Rent scheme. Fast forward to May 2020 and the distribution giant’s new acquisition is due to be metamorphosed into a £300m new last-mile delivery hub and multi-storey distribution facility.
It is not just Amazon getting in on the act. At the same time as spending over £50m on Ravenside Retail Park, off the North Circular Road in Edmonton, Robin Woodbridge of Prologis stated that “the UK retail market is changing, as more and more people order goods online. Because of this, our customers, who include household retail names such as Amazon, Argos and John Lewis, need logistics facilities close to where people live and work, so they can fulfil deliveries of goods ordered online efficiently.” The retail park houses occupiers such as Mothercare and Carpetright, but it is fair to assume that as soon those leases fall-in Prologis will look to redevelop the site to cater for this demand.
Economic forces are also likely to force a re-think in existing occupational requirements. Many landlords and tenants are suffering unimaginable damage as they continue to be hijacked by COVID-19. Despite recent government interventions to keep the oils of businesses greased, some will inevitably grind to a halt. Struggling property owners and occupiers will need to think about their current asset models and find ways to re-purpose and rejuvenate existing portfolios as a means to survive.
The notion of repurposing property for more relevant uses is something landlords and tenants have been toying with for some time. The rapidly changing face of the high street will not have gone unnoticed. Sparked by a shift in consumer habits, retailers have been moving away from outdated business models that rely purely on in-store purchases. This has already fuelled speculation that modern flexible spaces will eventually replace traditional retail footprints and it would also be fair to say that the impact of the current pandemic on consumer behaviour will not only fan those flames for change, but will force landlords and their occupiers to take action, reappraise their property requirements and find new ways to future proof their assets.
These tectonic shifts will change the nature of leases too. Despite the boom in industrial and logistics property in recent years, a boom which has by most measures seen it overtake retail and even offices as the most popular asset class, even industrials‘ stellar returns have to some extent been held back by the traditional 15 year lease structure. Well, not any more. Agents are reporting that average lease terms for industrial and logistics properties are now as low as seven years.
Canny landlords and operators have for some time been cashing in where possible on short-term occupational agreements to distribution companies to capture the Christmas rush and there are signs that landlords are increasingly willing to forego the old certainties of covenant, rent and term to meet pent-up demand. With an increase in need for alternative temporary space to hold stock during the current crisis, landlords have shown that they are prepared to agree short-term flexible leases to accommodate these requests. However, whilst this enables tenants to take advantage of these opportunities, shorter flexible leases are unlikely to come with long-term security. If the space is needed for an extended period, the lack of security will strengthen a landlord’s position for improved terms on renewal. On the flip side, a properly drafted flexible lease should give a tenant the freedom to exit early or assign the lease in the event that circumstances change and the property is no longer required. Given the uncertain times we currently live in, parties may prefer to stay fleet-footed rather than tie themselves into longer term contracts. Anecdotally, first half-year results revealed this week show that deals for 12-month lease terms (or less) have only accounted for 20% of all deals, so a sharp increase in short-term COVID deals does not seem to have materialised.
Tenants should also exercise caution when introducing new uses. Existing restrictions on use in a lease could stifle the tenant’s plans to convert redundant space into a storage facility and often use changes requires landlord’s consent. From a tenant’s perspective, widening the user clause may also have a negative impact on rent review.
A change of use may also be hampered by planning constraints. It would seem that there is no better case for more warehouse space than at present. Local government and public perception has been slowly catching on to the need for logistics space and the significant role it plays in our national framework will not be lost on them now. With a new generation of tech-savvy on-line shoppers emerging from COVID-19’s shadow there will be an even greater demand and acceptance for small sheds and mixed use sites that are both closer to and integrated in to the communities who need them.
Our commercial real estate team has extensive experience of working with investors in and developers of logistics space, as well as their occupiers. If you would like to discuss any of your acquisition, disposal or development requirements, or would simply like to explore how we might be able to help you with your property needs, please do not hesitate to contact Ian Craig, Partner, Commercial Real Estate or Markus Klempa, Managing Associate, Real Estate Disputes.