The polarisation of the office market
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A retreat from global supply chains is underway as businesses seek to maintain greater local inventories and production capacity. As global logistics networks are strained, businesses cannot yet fully enact their re-organisational plans despite a strong desire to do so. This implies momentum has yet to build and will only accelerate. More local inventory and production means more physical space required. With logistics and industrial/light industrial floorspace supply already at record lows across Europe, intensifying occupier demand will create even stronger rental impetus.
One of the most immediate and lasting impacts of the COVID-19 pandemic has been supply chain disruption. Erratic swings in demand – toilet rolls and computer monitors one minute, bicycles the next – were exacerbated by logistics interruptions ranging from congested ports and the Suez Canal blockage, labour shortages across the transportation industry and bans on certain exports deemed to be of national importance.
The extent of the disruption reflects the international nature of supply chains which first emerged in the 1980s enabled by new technology and globalisation.
A ‘Just-In-Time’ (JIT) supply chain philosophy in which decisions on where to source, manufacture and store stock are made purely on a financial basis has become standard practice. Goods and components are shipped on demand just before they are needed to minimise storage costs and optimise working capital. Production facilities are located in emerging economies with lower labour and operational costs.
The downside of JIT networks is that they rely on stability and do not cope well with sudden, unexpected change. Rapid demand fluctuations, shipping backlogs or border issues erode their functionality and undermine the ability of businesses to fulfil orders. Reliably mitigating disruption means prioritising resilience over cost, with higher volumes of inventory being stored and production being undertaken locally where it can be better guaranteed. This is the ‘Just-In-Case’ (JIC) approach, the benefits of which have been viscerally demonstrated by the pandemic and, as a result, a mass pivot towards it is underway.
A global survey of senior supply-chain executives by McKinsey, a management consultancy, in Q2 2020 found that 93% planned to make physical changes to their supply chains to ingrain flexibility, agility and resilience in response to the pandemic1. Multiple initiatives were planned including diversification of raw material sourcing, increasing critical inventory and nearshoring production and suppliers.
A survey of global CEOs by KPMG, a professional services firm, in Q3 2021 established that ‘supply chain risk’ was jointly ranked as the top threat to business growth alongside cyber security and climate change risk2. It was ranked second in 2020 reflecting the growing awareness of, and concern with, supply chain risk. There was a marked 10 percentage point increase in CEOs rating this as the biggest threat. Supply chain adaptation is clearly at the forefront of corporate agendas.
Rising risk & uncertainty: why change is occurring
Multiple factors are combining to foster rapid supply chain adaptation. The pandemic brought urgency to the need for change, ensuring that all businesses understand how fragile supply chains are and the need to ingrain resilience. Supply chain pressure rose immediately, reaching record levels in the Eurozone and the UK in June 2020 (figure 1). Pressure remains significant with global supply chain pressure peaking in December 2021. This reduces business output, erodes profitability and adds to inflation.
As with other structural changes though, the pandemic merely accelerated a pre-existing trend rather than creating it. Supply chains were becoming more localised and manufacturing activity was already nearshoring but the pace was much slower. The ability for supply chains to adapt is being fuelled by a variety of drivers (figure 2).
Ultimately the negative externalities of complex, lengthy supply chains and consolidated production have risen as uncertainty prevails and risk escalates. In parallel, the feasibility of nearshoring production and localism supply chains has increased. The cost/resilience balance is swinging in favour of the latter.
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 twice in Q2 2020 and Q2 2021. Analysis of the results clearly shows that whilst many companies planned to nearshore activity in Q2 2020, few had done so a year later. By contrast, far more companies had increased their inventories by Q2 2021 than the number of those that had anticipated doing so in Q2 2020 (figure 3).
Despite businesses increasing inventory, stock remains extremely depleted. Evidence from Capital Economics, a data provider, indicates that companies deem Eurozone manufacturing stock levels to be ‘too small’ by the largest margin in at least two decades after a sharp falling during the pandemic (figure 4).
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. Delivery times remain lengthy which prevents companies from building sufficient inventory (figure 5). It will be some time before these times shorten given the extent of the backlog.
Meaningful scale-up of nearshored 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 nearshore activity away from Asia 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.
Significant floorspace demand: occupier demand will escalate
Greater inventory and nearshored production require physical floorspace. Occupier demand for logistics, warehousing and industrial/light industrial stock will rise, compounding the existing supply/demand imbalance in favour of landlords.
In terms of specification, storage space requires little other than volume. This may mean that demand is focused on more affordable secondary logistics and warehousing space with height. The need for physical proximity to customers and producers implies that all European countries are likely to absorb rising demand and that transport connectivity will be a locational driver. Space near major transport nodes such as seaports, airports and multi-modal terminals may be most desirable.
Although modern production processes have lower labour requirements, labour is still needed. This suggests that Central and Eastern European (CEE) countries where labour is cheaper and more readily available along with lower operational costs may be most attractive. Western European markets are still easily accessible from the CEE. The BCI Global survey established that respondents considered CEE countries to be the most sought-after European countries for nearshored production. That said, the primacy of resilience over cost means that demand is directed towards western European countries too. Demand is expected to be focussed largely on industrial/light industrial space.
Production facilities typically rely on support from suppliers and logistics subcontractors. As such, the emergence of new nearshored production facilities will stimulate broader occupier demand in their surrounding localities. They are demand catalysts.
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 Europe is on the cusp of experiencing a sustained build-up of inventory storage and a transition towards nearshored 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 stronger, more protracted rental growth.
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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