Nascent stage: adaption is only just starting

The trend towards JIC is only starting to gather momentum. Because supply chains remain heavily disrupted and are likely to remain so for some time, it is difficult for companies to satisfy existing demand, build inventory and relocate production concurrently.

It takes time to recalibrate supply chains which have developed over decades. It takes even longer to relocate production facilities and increase output sufficiently to replace offshored factories. However, it is far quicker to store greater inventory than relocate factories.

The McKinsey survey was undertaken in Q2 2020 and Q2 2021. Analysis of the results clearly shows that whilst many companies planned to reshore activity in Q2 2020, few had done so a year later. By contrast, far more companies had increased their inventory by Q2 2021 than the number of those that had anticipated doing so in Q2 2020 (Figure 3).

Despite businesses increasing inventory, stock levels remain depleted. ABS data on business inventories indicates these fell significantly after March 2020 as the pandemic hit (Figure 4). Whilst proportionally inventory levels have improved in 2021, this reflects base effects given the severity of the reduction experience in 2020. Australian inventory remains extremely depleted by historical standards.

Despite businesses increasing inventory, stock levels remain depleted. ABS data on business inventories indicates these fell significantly after March 2020 as the pandemic hit (Figure 4). Whilst proportionally inventory levels have improved in 2021, this reflects base effects given the severity of the reduction experience in 2020. Australian inventory remains extremely depleted by historical standards.

A Q4 2021 global survey of 125 senior level executives in the life sciences, machinery/automotive and consumer durable goods sectors by BCI Global, a supply chain consultancy, found that 85% rated “shortage of components/commodities/raw materials” as the biggest supply chain challenge today³.

Manufacturing suppliers’ delivery times are at a multi-year low which prevents companies from building sufficient inventory (Figure 5). It will be some time before these times shorten given the extent of the backlog which will prevent significant inventory increases in the immediate future.

Meaningful scale-up of reshored production capacity is unlikely to be achievable until the medium term. Significant planning is involved, given the dramatic reorientation of process and supply chains that this involves as well as the high capital investment. That is why there has been little evidence of nearshoring production to date despite business indicating that they plan to do so.

Nearly 90% of McKinsey respondents stated that that they expect to pursue some degree of regionalisation during the next three years. This is corroborated by the BCI Global Survey which established that 60% of respondents plan to reshore activity within the next three years.

The implication of this analysis on the extent of supply chain adaptation and manufacturing nearshoring is that this recalibration is at a very early stage. It is only just starting to gather speed and it is a trend with longevity.

A rising tide lifts all boats: stronger rental growth is the most likely outcome

Analysis from a range of data sources and forward-looking business survey indicators suggest that Australia is on the cusp of experiencing a sustained build-up of inventory storage and a transition towards reshored production. This will lead to substantial and prolonged demand for additional logistics, warehousing and industrial/light industrial space.

A rising tide lifts all boats, even if demand is concentrated on storage and focused on secondary stock and production demand on light industrial/industrial, it will still limit choice and reduce optionality for occupiers across all types of logistics and light industrial space. This is likely to intensify competition for space, exacerbate the existing supply shortfall and lead to stronger, more protracted rental growth.

_Footnotes

^{1 McKinsey, 23 November 2021, How COVID-19 is reshaping supply chains
2 KPM, 1 September 2021, 2021 CEO Outlook
3 BCI Global, 16 February 2022, Global Reshoring & Footprint Strategy}

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Logistics Pan-European diversification

Another option for distribution-seeking investors is to expand into other higher-yielding European markets. Prime logistics yields of 4.25% in the Czech Republic, 4.35% in Poland and 3.95% in Italy are clearly appealing relative to Germany (figure 1). Occupier demand for quality stock in these markets is rising and land supply in the top locations is tight.

Not only will pan-European diversification bolster distributions, but it also spreads income risk by gaining exposure to assets and occupiers subject to different country dynamics. This reflects both the unique economic prospects of each European country and, of particular relevance to logistics performance, differing stages of online retail market maturity.

Countries with ecommerce penetration of below 10% of total retail spending are immature. Analysis from mature markets such as the UK and Netherlands demonstrates when penetration rises above 10%, logistics occupier demand also accelerates. The demand impetus typically proceeds faster than the supply response, especially given it is increasingly hard to find sites and gain permission for new logistics development, leading to rapidly escalating rents. Rental growth tends to endure when markets reach maturity above 18% penetration as occupiers seek to consolidate their distribution networks to maintain market share.

Many European countries have recently entered the maturing stage of ecommerce growth (figure 2). In addition to Germany (16% online penetration in 2022 according to CBRE) these include the large Italian (10%) and Central and Eastern Europe economies (14% and 17% in Poland and Czech Republic respectively). This bodes well for future rental growth prospects in these countries and those who invest there.

Wise pan-European diversification requires a robust understanding of local market dynamics. Whilst logistics stock is fairly generic, local country particularities have a significant impact on return prospects and requires granular market expertise in order to make informed decisions.