Brexit and the logistics market

As the prospect of a disorderly Brexit grows, logistics investors are evaluating the potential costs and benefits of the UK’s impending divorce from the European Union.

In mid-January, the Brexit sound and fury reached deafening levels as the UK parliament overwhelmingly rejected Theresa May’s withdrawal agreement. In the meantime, the country’s logistics operators, retailers and manufacturers were quietly buckling down to the task of preparing against the growing possibility of a disorderly exit from the EU.

For some months, occupiers in the industrial sector have been vacuuming up excess distribution space (see below) to ensure their supplies keep flowing if there is chaos at the ports. For the immediate future, that is good news for anyone with a vacant warehouse to let, but the longer-term effects are less clear-cut.

More than 40 years in a shared European market has shaped the cross-border supply chains on which UK business relies. Depending on the trade deal eventually struck with the UK, most Brexit scenarios involve some extra friction at the country’s borders, and in the case of a no-deal Brexit on World Trade Organization Rules (WTO) serious delays are likely. The Port of Dover estimates that if each truck takes two more minutes to pass through customs, that would create 17-mile backups on the motorway network. How could ongoing disruption impact the future of UK logistics warehousing and its attractiveness to real estate investors?

Opportunity knocks

The most likely consequence is one that will please warehouse landlords: increased demand for space. “Whatever trade deal we end up with, the supply chain dynamic will alter. It is about managing two sides of an equation: capacity and flow. If you interrupt flow, you need more capacity to maintain the same delivery times. That means more warehousing,” explains Peter Ward, chief executive of logistics sector trade body, the UK Warehousing Association.

For Ward, that is part of a “perfect storm” of adverse conditions battering his members that also includes a shortage of speculative-built warehouse space and land on which to construct it, and a skills and labour shortfall compounded by a fall in sterling that has made the UK a less attractive destination for warehouse workers from eastern Europe.

Those conditions have been less troublesome for logistics real estate, however. According to CBRE figures, 2018 big-box warehouse take-up in the UK reached an all-time record 31.5 million square feet. The sector is more likely to view Brexit disruption in a positive light, suggests Walter Boettcher, director of research and forecasting at Colliers International and author of a report on Brexit property impacts: “Investors and developers see the imminent changes in supply chains as creating a huge amount of opportunity to revisit the existing supply structures and develop new facilities to accommodate whatever changes are coming as a result of Brexit,” he says.

Brexit may lead to changes in the location of warehousing as well as the quantity of demand. Ward predicts that some UK businesses that have been supplying continental Europe from domestic warehouses will look to open facilities across the channel. The converse will also apply, he predicts: “There are companies supplying into the manufacturing and retail sectors with just-in-time delivery from warehouses in the Benelux region that are saying they will have to have a UK hub now.”

Soft or hard deal… and why it matters

Increased need to reserve space around ports to carry out customs inspections could boost real estate activity both portside and elsewhere, argues Mike Hughes, CEO of logistics investor-developer Verdion. “The principle of our iPort inland port scheme near Doncaster was to take shipments by rail from ports like Felixstowe and Southampton that want to reduce congestion portside. In a Brexit situation there is an opportunity for inland ports to do even more business. We are applying for bonded status at iPort so you can do customs checks there.”

While supply chain restructuring forced upon tenants may well benefit landlords, the long-term economic consequences of a form of Brexit that makes it harder and more expensive to do business are potentially damaging. “The question is, will it be a soft or hard Brexit?” asks Olivier Téran, chief investment officer at Allianz Real Estate.

3m square feet

Warehouse space required to hold nine days’ supply of parts at Honda’s car plant in Swindon

“The UK remains under-provisioned in large modern facilities, and if GDP growth and consumption remain at their current level I think the demand for space will remain strong. That demand was demonstrated by takeup for the first three quarters of 2018 that was up 18 percent compared with the same period in 2017. In the case of a hard Brexit, the economy will suffer. If we see the pound devaluing by a further 10 to 15 percent and a recession, that will hit all segments of the economy including logistics. Production and consumption will slow down, which should have a negative impact at a minimum on future asking rents given strong development pipeline, and possibly on vacancy. That is the concerning issue for hard Brexit in the long run.”

While a consumer market of 66 million people will always generate demand for distribution warehouses for retailing, there are concerns that the disruption caused by a hard Brexit might force manufacturers to relocate outside the UK. Carmaker Honda has estimated that parts arriving from Europe could take as long as nine days to reach its plant in Swindon, and that holding so much stock in reserve would require more than 3 million square feet of warehousing, a prospect that is neither practical given the space available, nor affordable.

“Arguably the China-USA trade war has been instructive here,” says Sabina Kalyan, global co-head of research at CBRE Global Investors.

“In the case of a presumed short-term disruption, operators find workarounds or simply add to the cost of operations. They can choose to take the hit on their margins or pass it onto the consumer. However, if the assumptions shift to long-term disruption – a no-deal and then protracted negotiation for a new trade deal – then we would see what is starting to happen in China: operators shift capacity to non-affected markets, in the case of China to Vietnam and other lower-cost South-East Asian markets, or in the case of Brexit to EU markets.”

On the other hand, she observes, a further fall in the value of the pound could act as a powerful stabiliser: “An interesting question is whether the increased costs will be offset by the cheapness of UK real estate via the devaluation of sterling and a property price correction.”

For the logistics property market, as with all other areas of the UK’s economy and society battered by the turbulence of Brexit, it seems that the only certainty is uncertainty.

Building a Brexit buffer

Warehouse occupiers scramble for space as ‘Brexit day’ approaches

Whatever the long-term impact of Brexit may be, many UK companies have been seeking to draw the sting of a potential crash-out Brexit on March 29 by taking additional logistics space to provide a buffer of stock and supplies. “Usually in early January you expect a bit of a lull while stocks start to rebuild after Christmas,” says Ward. “Last year and the year before our members might be running at 75-80 percent of capacity, but this year as a result of Brexit enquiries that is more like 95 percent. We have a mass of anecdotal evidence that there has been an upsurge in demand for warehousing space.”

A survey of UKWA members conducted in December 2018 shows 85 percent have received Brexit-related enquiries. “It started trickling through the summer, gathered momentum in September, and as the likelihood of a day one no-deal scenario began to mount through November and December it really started to escalate.”

In real estate terms, the impact of that increased demand is likely to be limited because most requirements are for short-term storage, and many are likely to result in existing unfilled “incremental” space being taken up. However, some UK investors have sought to turn the situation to their advantage. “Contingency planning is driving short-term requirements and we deliberately put in place in the summer a strategy to go and buy relatively unloved buildings in very prime locations in order to capitalise on that,” says Stewart Little, co-founder of logistics asset manager Oxenwood Real Estate.