Community of Inquiry article series
2016.03.18 • published on LinkedIn
Logistics industry from the institutional investor's perspective
Article 4: Renting the business premises
1. With respect to this article series
This is the fourth article in a Logistics Community of Inquiry series in the following four linkedIn groups:
||Global Logistics & Supply
Chain Professional Group
For a more comprehensive elucidation of the purpose and objectives of this CoI (Community of Inquiry), please read the first
article in this series. The first article in the series deals with investment considerations from the perspective of an
institutional investor, examining macro-economic factors, location characteristics, technical due diligence, and important
legal and tax issues. The second article explores issues of risk mitigation in the supply chain structure and the ways
landlords may (partially) support this mitigation.
The third article looks into the alignment of site selection criteria among investors and logistics service providers (LSP).
In this fourth article, we will focus on three different impediments to effective lease agreement negotiations between
the landlord (investor) and the LSP. First, we will discuss the issue of rent, followed by a discussion of lease term
flexibility, and finally we will look at issues of occupancy.
2. Talking about rent and other costs
Rents in the logistics sector are given in Euro/sq m per annum and are generally valid for premises with heating and
good communications infrastructure located within industrial or logistics parks. Rack storage is not normally included.
Rents stated are net rents, meaning ancillary charges, incentives, and other benefits are excluded. Rents given are
nominal values. Commercial rents are devided into prime rents and average rents. Prime rents are defined as an average rent
of the top 3-5 % of all lettings in each submarket. As this is a mean figure, it does not indicate the best rent level
realised. The average rent is a weighted average of all rents within a submarket. Average values are not necessarily
strict mathematical means, modes or medians, but tend to describe the typical, common rent level for each submarket (RIWIS, 2016).
Rent is a part of an LSP's operational expenditures, which places it in a basket with other costs such as:
- cost of transport activities
- cost of storage or warehousing
- cost of time value
- Investment in logistics systems, including the added value of transportation
- cost of physical alterations required for effective and/or safe transport, storage, and handling
- cost of marking, identifying, recording, analysing, transferring and handling data
- cost of stacking/unstacking
- cost of added packaging
- cost of material transfer
- cost of consolidation/deconsolidation activities
- cost of information and telecommunications integration
- cost of logistics system management
- losses due to unavailability of goods (when arises).
In general, the costs of transport and non-physical handling activities, such as inventory and related time costs,
constitute the majority of logistics costs (United Nations ESCAP, 2003).
Cass Logistics System Inc. calculates and publishes logistics cost statistics annually for the United States in
their "State of Logistics" report. The report breaks down overall logistics costs into three key components:
transportation costs, inventory carrying costs, and administration costs.
Figure 1: US business logistics system cost 2015 (Wilson, R., CSCMP 2016., adapted by author)
Inventory carrying costs include the cost of money (opportunity or interest), ad valorem taxes, insurance and shrinkage.
Inventory carrying costs include those costs that vary with the level of inventory stored. They can be categorized into
the following four groups:
- Capital costs
- Inventory service costs
- Storage space costs
- Inventory risk costs.
Rent is included in the 143bn USD of storage space costs (33% of total system costs). For the Cass report, storage
space costs are incurred at four types of facilities:
- plant warehouses
- public warehouses
- rented (leased) warehouses
- company-owned (private) warehouses.
Area Development (2015) breaks down the costs on a more detailed scale in their 24th Annual Corporate Survey. These findings
were then reconfirmed by a survey by Establish, Inc. / HWD & Grubb & Ellis Global Logistics, cited in Rodrigue, J-P.
(n.d.). Finally, Jones Lang LaSalle (2015) also conducted their own research and the outcome was in line with the
conclusions of Area Development and Rodrigue.
Figure 2: Splitting up logistics industry costs by main categories (Jones Lang LaSalle, 2015)
These surveys show that rental costs make up approx. 4.3% of the total operating supply chain costs in the logistics industry.
In theory, the impact of rent increases or decreases should therefore be of minor importance to the logistics provider.
This conclusion is supported by the 2014 PWC/FTA logistics survey, which explores the main concerns to CEOs across the
globe as they deliberate, plan and invest for the future.
Figure 3: Main issues of concern to the logistics industry (PWC/FTA, 2015)
Here we see no evidence that the logistics industry sees future rental levels as a dangerous or disruptive factor in
In another part of the survey regarding issues the CEOs were likely to encounter, rental costs were again of no importance.
Figure 4: Main issues of concern to the logistics industry (PWC/FTA, 2015)
Why then are rental costs often such a big part of the discussion between landlord and LSP when negotiating rental
contract conditions? Based on everything we know, this is a nominal factor at best, but, as it is always a point of
dispute, there must be some underlying reason here.
The reality is that costs do play a pivotal role. Perhaps by looking at LSP costs more closely we can see why.
3. Logistics costs analysis
Problematically, the logistics industry is not very keen on revealing the ways they calculate their costs, likely due to
competitive considerations. Finding a transparent and universally applicable cost calculation model seems therefore
For the remainder of this article we will therefore take the costs of storing a skid or pallet in 3PL as an example.
The example below illustrates a rough calculation of pallet position pricing.
Figure 5: Rough calculation of pallet position pricing (Author, 2016)
In this calculation, rent costs have a significant influence on warehouse costs (22% of total warehouse costs).
4. Adjusting rent costs
Continuing with the former warehouse example, a simple table can be compiled showing the correlation between reducing rent
costs and its influence on total warehousing costs. This example will examine an building with a surface area of
15,000 sq m and a starting rent of €70 sq m per annum. See table 1.
When an institutional investor gets involved, adaptation of the rental price influences the total annual cash-flow and
thus the purchase price. If we extend table 1 to include the purchase price as a factor of annual income, we see a huge
reduction of the purchase price. The assumption for table 2 is that a capitalisation rate of 15 (yield approx. 6.5) is in
conformity with market circumstances (2016). The purchase price is represented as a rounded figure.
Table 1: Correlation between rent and total warehouse costs (source: author)
Table 2: Influence purchase price vs. diminished cash-flow (source: author)
This simplified model becomes a bit more complicated if you add the role of a warehouse developer or contractor to it. A
warehouse of approx. 15,000 sq m will generate construction costs of approx. €300 sq m, so in total €4.500.000.
With a needed footprint of 30,000 sq m land to put the building on (50% built area), the estimated purchase price of
the plot will be 30,000 sq m x €100 sq m = €3,000,000.
The total costs for the developer/constructor are €500,000. To maximize their profits with the sale of the premises,
the developer will need to achieve rental prices well over €40 sq m p.a., although this may in reality be closer to
the true market value. By giving the logistics tenant incentives via rent-free periods or cash payments, the tenant
can be persuaded to close on a contract, even despite the inflated rent price.
A year in, however, the incentives will have run out, and the logistics tenant will find himself paying warehouse
costs that are much too high when compared to what he earns out of his operations. In the end, this leads to
continuous future discussions on the rental level between landlord and tenant.
If, however, they can agree to flexible rental prices, both parties could profit. Looking at the graph below, we can
see that rental prices will continue to develop through 2017. At that point, they are predicted to drop through 2020,
meaning both parties would gain an advantage on one end or the other.
Figure 5: Modest growth of logistics rents in Europe (source: CBRE, 2015)
5. The rental period
Another important part of the lease agreement between the landlord and the 3PL is the duration of the lease agreement.
For institutional investors, finding long term real estate investments with a strong and consistent cash flow are
necessary preconditions for their shareholders. Achieving this in offices, hotels, retail and parking garages is
quite easily. With logistics housing there is a different approach.
Varying customer behaviour, technical developments and changing demand generate systematic variations in order and
material flows, which result in changes to the logistic networks.
Because of these market dynamics (with some exceptions), LSPs typically conclude service contracts with a duration
of 3 to 5 years maximum. Only in some exceptionally trusting business relationships will you see contracts lasting
10+ years. With a 3 to 5 year contract, the LSP often gets a bit more of a management fee in the beginning to start
up the business. The longer the contract lasts, the lower the fee becomes.
In general, businesses outsource to LSPs because they expect to gain some of the following advantages and opportunities
(Gudehus, T. & Kotzab, H., 2012):
- higher limit performances and larger store capacities
- improved service quality due to professionalism and specialization
- higher flexibility due to extensive resources for several customers
- lower costs due to high efficiency and better utilization
- favourable wages and salary structures due to other tariff agreements.
Competition, market turbulence, cost savings and flexibility can strain the relationship between landlord and tenant,
especially when the landlord's assumption on lease agreement durations differ from the reality of the industry.
This might mean the institutional investor needs to adapt his portfolio performance expectations, though this does
not mean they must do so at the expense of property performance. On the contrary, by being flexible in the relationship
with the LSP, logistics real property can easily outperform other asset classes such as offices, hotels and retail.
Figure 6: Prime logistics total returns Europe 2015-2019 (source: Deutsche Asset & Wealth Management, 2015)
Figure 7: Estimated Yield development Europe to 2020 (source: DekaBank, 2015)
Figs. 6 and 7 clearly indicate the attractiveness of the logistics and light industrial market as an asset investment class.
To maintain steady growth in a logistics portfolio's performance, however, institutional investors and LSPs should consider
working more collaboratively with regard to lease agreement duration. Most of the time, providing the LSP with a lot of
flexibility in duration (and sometimes in available space) means the LSP enters into a long term relationship with the
landlord and tedious discussions about the rental level can be avoided.
The investor should not forget that LSPs have a lot of bargaining power due to their scale, global business importance,
resourceful network, market reconnaissance and in-depth body of knowledge regarding supply chain processes. Appendix 1
of this article gives an overview of the 20 largest 3PL worldwide (ranking 2011). The total logistics industry turnover
in 2011 amounted to 981 Million Euro (Roland Berger Strategy Consultants/Barclays, 2014), meaning the logistics sector
carries a great deal of economic importance and impact.
Figure 8: Importance of the global logistics industry (source: Roland Berger Strategy Consultants/Barclays, 2014)
6. Space flexibility
Flexibility within logistics management is crucial to maintaining efficiency and accuracy in shipping processes. Flexibility
refers to the scalability and adaptability within a given system to improve the effectiveness of shipping processes
(Robinson, 2015). Warehousing providers are permanently seeking ways to increase flexibility, improve inventory control,
manage costs, and streamline the supply chain. They try to achieve this by supporting manufacturers and other clients through:
- Shared space environments which accommodate shipping peaks and valleys by balancing multiple manufacturers' requirements with complementary surges
- Bringing functions such as secondary packaging closer to the customer. This allows them to delay product configuration until the last minute to meet current demand. This now takes place in the warehouses
- Moving products more efficiently and cost-effectively by using cross-docking - moving product directly from receiving to shipping with little or no inventory and minimal handling. This process is resurfacing as a way to reduce costs in the supply chain, accelerate inventory velocity, and improve service levels.
Investors should keep in mind that the increasing demand for better quality modern space does not mean that organisations
are not under pressure to reduce costs. One could argue that occupiers recognise that paying more for the right kind of
building in the right location can produce greater cost savings and efficiency across the business.
This means that the investor who offers short and flexible solutions will come out on top. This is particularly true of
specialist logistics firms, but some manufacturers, once tolerant of older, smaller buildings in sub-optimal locations
with lower rents, are now also becoming less willing to take this kind of space.
Again, this contradicts what institutional investors are used to, but their flexibility in space requirements and lease
duration will ultimately lead to steady long-lasting relationships with LSPs with less squabbling about the rental price.
Offering full flexibility, especially when tailored to the LSP, will result in profit growth rather than insecurity.
7. In conclusion
Although no conclusive argumentation can be found on the influence of rent costs in the total operations of the logistics
supply chain, one can argue that rent is a substantial part of warehousing costs, thus impacting 3PL profits.
If 3PLs are not open to sharing cost and profit, institutional investors will remain reluctant to discuss rent.
A good starting point could be more transparency in the relationship between the institutional investor and the logistics
provider, particularly openness regarding the cost structure in the supply-chain. This would be an important instrument
for finding common ground.
Along with rent prices, the two other important negotiation points are flexibility in the duration of a lease agreement,
and flexibility in the provisional cutting or adding of space. By emphasising duration and space flexibility, an
institutional investor will likely be able to avoid cumbersome discussions on rent levels.