European Logistics: Adjusting to the new normal

Introduction

The European logistics sector has seen dramatic change over the past decade with demand for space surging, in particular in response to pandemic-changed behaviors. Moderating take-up is now a sign of a slowing market. However, some of the influencing factors are beginning to stabilize. The outlook for the sector remains positive, forecasted to outperform the wider market. We believe occupier demand will settle above (pre-pandemic) historic averages. Several important structural factors underpin our view, which we will outline in this paper.

Current market conditions

European logistics take-up (across the ten largest markets) totaled 24.1 million sqm over the 12 months through Q2 2023. A comparison with the peak figure of 35.1 million sqm, achieved a year earlier, could understandably cause concern. The peak, however, was achieved because businesses sought more logistics space to respond to increased e-commerce consumer demand precipitated by the pandemic. As such, it does not represent an appropriate benchmark. Take-up over the past 12 months is still around 10% above the average recorded over the period 2014-2019. In addition, as highlighted in the latest CBRE European Logistics Occupier Survey, occupiers are still in an expansionary mode in Europe. Of survey respondents, 67% reported that they are planning to expand their European logistics footprint. To date, the slowdown in take-up has only had a minor impact on the vacancy rate. Pan-European vacancy is marginally higher than it was a year ago but remains below 3%, compared to the 2015-2019 average of 4.5%. Low vacancy is continuing to put pressure on rents, which have continued to increase year on year for the majority of European markets.

Logistics vacancy rate, Europe (%)

Annual rent change across European logistics markets, % of all markets

The New Normal

While the logistics sector saw occupier demand increase significantly in recent years, the record-breaking levels seen in 2021 and 2022 were never expected to be sustained over the long term. Demand will likely settle back close to levels seen in the years immediately prior to the pandemic.

Of course, demand (and supply) will continue to fluctuate with cyclical factors, but more importantly, several structural demand drivers remain in place. We will discuss some of the main ones below.

E-Commerce

E-commerce has been a drag on recent take-up that we are confident will return to growth over the medium term. E-commerce is the most cited structural demand driver for logistics real estate, with estimates suggesting that every additional $1bn of e-commerce sales requires 1 million sq ft (93,000 sq m) of dedicated logistics space. E-commerce demand can be lumpy however, with occupiers embarking on bursts of expansionary activity before pausing.

Today, we find ourselves in one of these pauses. Over the past year, e-commerce occupiers have accounted for 5% of total take-up, which is down from a pandemic peak of 20% and the average preceding the pandemic of more than 10%. It was inevitable that e-commerce growth would slow following the pandemic as access to physical retail was restored, but there is still considerable headroom for further growth. CBRE estimates that e-commerce accounted for 18% of European retail sales in 2022 and that this share will increase to 24% by 2027.

E-commerce share of retail sales, Europe, % of total

Reverse Logistics

An emerging consequence of continued e-commerce sales growth, is the issue of returned items. The process of moving goods from customers back to sellers and manufacturers is known as reverse logistics. Brick-and-mortar retailers, while less convenient than online shopping, offer the ability to see, touch, and try on dozens of items to ensure the best fit, size, and appearance. With consumers moving away from physical locations, many have gotten into the habit of purchasing ‘try on’ items with the intention of returning items they do not like.

Research firm Statista reports that as of June 2023, 53% of survey respondents in the U.K. sent back an article after ordering it online in the past 12 months—a figure two to three times higher than for items bought in-store. Since consumers expect same- or next-day delivery, as well as the ability to return items at no-cost, retailers are factoring this into their business models, leading to a further increase in logistics space demand. 

Supply Chain Reconfiguration

In addition to e-commerce, the wider reconfiguration of global supply chains will continue to drive demand for logistics space. Supply chains that halted during the early stages of the pandemic remained under considerable stress for a prolonged period as consumers focused their spending on goods often manufactured in distant parts of the globe. To catch up with demand, in early 2022 inventories across Eurozone businesses grew by a significant €60 billion year-on-year. Growth at these rates were an anomaly, but influenced supply chain planning for the foreseeable future due to the need to hold greater inventory near to the consumer or end user.

Re/nearshoring

Despite the challenges caused by the pandemic easing, supply chain issues remain a top of concern for European businesses. For many years, businesses in Europe offshored product manufacturing to distant locations, often in Asia Pacific. Recent global economic shocks and supply chain disruption have illuminated the length of time and complexity of how we source products we make, move and consume. The rising costs of labor, cost of transport, geopolitical factors and social impact, amongst others, are driving businesses to examine their sourcing and supply chain strategies. As a result, Eurozone businesses are increasingly considering nearshoring of production and supply. According to the CBRE European Logistics Occupier Survey, 17% of the respondents reported they had already near-shored production or suppliers to Europe.

A 2022 survey by ABB found that 74% of European businesses were planning to re- or nearshore operations to “build their supply chain resilience in response to labor shortages, the need for a more sustainable global footprint and global uncertainty.”

Moving production closer to markets of consumption becomes more attractive when the cost advantages of being offshore versus maintaining control and flexibility no longer favour remote locations. Nearshoring, along with other investment decisions, has driven significant growth in occupier demand for floorspace. These buildings, especially at the larger end of the size spectrum, are more likely to be built to suit. 

Constrained Supply

Future demand from occupiers will have more difficulty being met due to significantly less available space than during the pre-pandemic years. Construction activity, having passed its peak and down 20% since early 2022, will not meaningfully change the balance of supply and demand in the market. Further upward pressure on rents is expected as demand continues to outpace supply.

European logistics construction activity, million sqm

In the short to medium term, the supply pipeline of new logistics space will be constrained given increased construction costs, economic uncertainty and changed development economics. However, as inflation declines and interest rates are cut, financing and construction costs will ease. In addition, given the continuation of strong demand drivers for logistics space, the business case for developing logistics assets will continue.

With increased focus on sustainability in general and environmentally sustainable assets, there is an increased tightening in terms of regulation for new construction. Recent regulations restrict new construction on greenfield sites. The EU has set the objective of no net land take by 2050, thus, new development in the EU will need to be on brownfield land or compensated for by rewilding developed land if building on greenfield land. The French and German governments have already imbedded these issues into national plans and other member states are expected to follow. These new regulations will potentially have a further negative impact on the supply pipeline and increasing competition for already existing space.  

Conclusion

Occupier variables still point to a resilient market where demand outpaces supply. Structural drivers also point to future demand for logistics space. At the same time, supply pipelines will be limited. These factors leave us confident that competition for space will continue and rents will grow ahead of inflation, albeit below recent double-digit rates. The ‘new normal’ still looks very attractive.