When Western European companies sought to enter Poland in the late 1990s, the newcomers faced an immediate problem: a dearth of suitable warehouses. While they strived to gain a foothold in the former Communist country, multinational retailers and manufacturers stored goods in small brick houses and even sheds left over from World War II concentration camps.

As sales proved promising, the Westerners began to build 3,000 sq. meter facilities (32,280 sq. ft.). That trend toward bigger industrial facilities was just the beginning. Corporate expansion in Poland during the past few years has led to a new generation of distribution centers exceeding 300,000 sq. ft.

“The facilities we are building in Poland now are as good as any in the world, with high ceilings and easy access at loading docks,” says Robin P.R. von Weiler, managing director of ProLogis, a real estate investment trust (REIT) based in Aurora, Colo., which recently completed a 451,920 sq. ft. distribution center in Poland for use by Unilever PLC.

Poland is not the only country where developers are redesigning warehouse and distribution centers. With trade expanding throughout the European Union, companies are forced to rethink how they store and distribute products. In the past, many businesses owned and operated small local facilities. Now, to cut costs and streamline marketing efforts companies are moving to larger regional properties that rely on a new generation of computerized logistics systems, mirroring a decade-long trend in the U.S.

The modern centers have won new attention from real estate investors. Pension funds and other institutional investors that once ignored European warehouses are now bidding on prime facilities.

“The industrial segment was the Cinderella of the European property markets,” says Elaine Rossall, a research analyst in the London division of brokerage Cushman & Wakefield. “It was seen as the least attractive market for investors. But now institutions view it as a relatively steady area.” A big buyer of industrial space is AMB Property Corp., a San Francisco REIT that recently announced it had spent $19.7 million to buy a warehouse with 164,000 sq. ft. in Frankfurt.

Rising Prices

During the past two years, capitalization rates — the initial yield an investor receives based on purchase price — have fallen by more than 100 basis points in many markets. Cap rates in the U.K. average about 6.5%, according to Cushman & Wakefield.

In Eastern European cities, such as Budapest and Warsaw, the rates are considerably higher — typically above 10% — because of greater risks and less competition. The yields have dropped at a time when the European economy has remained sluggish, with many countries reporting annual increases in gross domestic product (GDP) of less than 2%.

Part of what appeals to investors is that warehouses have proven to be relatively resilient in hard times. While the office sector in parts of the U.K. and other countries has suffered from vacancy rates in the teens, warehouse vacancies have hovered around 6%, according to Deutsche Bank.

“In the office sector, we have millions of square feet available and we have seen a big drop in effective rents,” says Simon O'Donnell, managing director of London-based Hines Air Property, which is a unit of giant office developer Hines, a private real estate company in Houston. “The warehouse sector has held up pretty well.”

Rents for distribution space have climbed slowly or fallen a bit in most countries (see chart, above). From 2001 to 2003, rents rose at an annual rate of 1.4% in the U.K. Conversely, rents dropped at an annual rate of 1.4% in France during the same period due to a lackluster economy. France's GDP grew at an annualized rate of only 1% in 2003. According to Cushman & Wakefield, the U.K. boasts some of the most expensive rents in Europe. Rents in London were 132 euros per sq. meter per year in 2003 compared with 53 in Paris.

Warehouse rents have stayed relatively firm because the sector has not been plagued by huge amounts of excess space. Part of this good fortune can be attributed to the fact that the facilities can be built quickly, making it easier for developers to react when opportunities arise or stop new projects as vacancies mount. An office project can take three years to complete, but a warehouse can be built in six to 12 months.

Where Projects Are Sprouting Up

Faced with slow economies across the pond, few developers are building on speculation. But the market for build-to-suits, or custom-designed buildings, is alive and well. In the next year, development activity should remain brisk in Eastern Europe where companies are rushing to meet rising demand.

Developers also have plans to build new facilities at airports and strategic highway locations where demand remains strong (see related story, page 32). But in much of the U.K. and Germany, development is likely to be limited. “The economy is just beginning to pick up, so it will probably be a year or so before we will see much more construction,” predicts O'Donnell of Hines. Gross domestic product in the U.K. has been growing at an annual rate of 3.5%, compared with 2% in Germany.

Much of the recent construction can be traced to the emergence of the European Union (EU). Before Europe demolished trade barriers, truckers had to clear customs every time they crossed a border, and each country had different regulations governing trucks. To steer clear of such trading obstacles, multinationals set up a separate distribution system in each country.

Those days are now gone, and with the admission of eastern European nations into the EU, truckers can now easily roam over much of the continent. “In the past, a company might have had a 50,000 sq. ft. warehouse in France, and similar ones in Spain and Italy,” says Guy F. Jaquier, chief investment officer of AMB, which owns 104.5 million sq. ft. of industrial space in Europe and around the world. “Now, it is cheaper to have one 200,000 sq. ft facility in the south of France that serves all three countries.”

The Emergence of 3PLs

Faced with tough global competition, businesses insist on squeezing costs out of their new warehouses. Many manufacturers that have long owned warehouses are engaging in sale-leaseback transactions. That frees up capital to invest in fast-growing businesses. In addition, many owners that once operated their facilities are outsourcing management duties to companies known as third-party logistics suppliers, more commonly referred to as 3PLs. In some cases, the outside suppliers lease space, provide trucks and take care of all distribution duties.

The logistics specialists are growing rapidly because they cut costs and handle tasks more efficiently than companies can on their own. The ranks of third-party suppliers include big companies, such as Nippon Express Co. Ltd. and DHL, a unit of Deutsche Post World Net.

These giants enjoy economies of scale when they purchase and operate computerized logistics systems. Perhaps most importantly, the suppliers ensure prompt deliveries. That enables companies to keep a minimum amount of inventory on hand and bring new products to market quickly.

In many cases, new facilities are built to suit the demands of third-party suppliers who hold the leases. The new construction focuses on maximizing ceiling heights. Whereas some older buildings measure 492 feet long and 32.8 feet high, some of the new structures are 328 feet long and 98.4 feet high. The idea is to pack more goods into a smaller floor space. That way forklifts can shuttle up and down aisles quickly and move goods in and out faster.

As they take over newer facilities, the largest logistics companies have been swallowing up smaller firms that do not have the capital to compete. The rise of the big logistics suppliers is helping to attract institutional investors into the warehouse market. Few pension funds would bid on a building operated by a mom-and-pop company with two trucks. But when a property is leased to a billion-dollar public company, then real estate becomes a blue-chip investment.

Prologis works closely with logistics companies, helping to develop long-term plans. The warehouse owner has 18 leases with DHL throughout Europe. Recently DHL won a big contract from Epson, the Japanese maker of inkjet cartridges and other computer supplies. When it became clear that the cargo company's existing facility at the port of Rotterdam was too small, Prologis offered to build a bigger distribution center.

“We just tore up the contract on the old building and released them [DHL] from any risk,” says von Weiler of Prologis. “Our goal is to be a long-term partner of good customers.”

Building Along the Highways

Because it is difficult to assemble land in cities, many new distribution centers are built at key highway intersections or along roads that ring major cities. In June, Prologis completed work on a 387,360 sq. ft. facility located 12 miles south of Paris in Evry. The facility is leased to ID Logistics, a leading French third-party logistics company, which holds seven leases from Prologis for a total of 2 million sq. ft.

One of the most popular sites for distribution centers is in the Midlands section of Britain, located between London and Birmingham. Annual rents in Midlands are only 83 euros per square meter compared with 132 euros near London, according to Cushman & Wakefield. Because of the central location in Midlands, trucks leaving the area can reach anywhere on the island within a day's drive.

Attracted by the convenience and lower costs, retailers have been especially eager to lease space in Midlands. In the second quarter of 2004, Tesco, one of the largest British supermarket chains, leased 495,000 sq. ft. of space from Prologis in Midlands. Prologis also leased a 162,000 sq. ft. facility nearby to John Lewis, which owns 26 department stores and 162 supermarkets in the U.K.

In Eastern Europe, demand for distribution centers remains strong among a range of retailers and manufacturers. In 2004, 10 countries joined the EU — including Poland, Hungary and the Czech Republic — and companies from around the world are rushing to tap the new market.

For manufacturers, the appeal is an abundance of cheap labor. While hourly labor costs are above 25 euros in Sweden, they are about five euros in Poland. Carmakers have been eager to shift production to Eastern Europe, and parts suppliers have followed. Retailers have joined the parade.

To service Hungary, ProLogis recently began development of a 250,000 sq. ft facility near Budapest. The property will be leased to Geodis, a logistics company that already leases 850,000 sq. ft from ProLogis in France, Spain and the Netherlands. Rents in Budapest are moderate, averaging 60 euros per sq. meter per year, according to Cushman & Wakefield.

But developers prefer the area because construction costs are modest. Besides demanding low wages, eager workers are willing to labor 18 hours a day. That kind of drive will help to keep the Eastern European economies expanding. “The Eastern Europeans are eager to grow,” says von Weiler, “and that should ensure healthy demand for distribution centers.”

Stan Luxenberg is a New York-based writer.

Why Developers Are Hurrying to the Airports

While distribution centers are sprouting in many parts of Europe, some developers are heading straight to the airports. San Francisco-based AMB Property Corp. has recently purchased or developed facilities at airports in Amsterdam, Paris and Frankfurt. The reason for the activity? Air cargo volume is soaring.

AMB's chief investment officer Guy F. Jaquier says when the global economy grows by 1%, international trade rises 2%, and the air cargo business increases by 4%. “The long-term supply and demand characteristics for airport properties appear to be the best in our business.”

Part of the growing demand stems from changes in the nature of manufacturing. Two decades ago, BMW made all its cars in Germany. Now, parts are made all over the world. Crucial components must be shipped quickly to plants so assembly lines can continue running. In addition, more perishable goods are being shipped by plane. Expensive computer parts and even sneakers are sent by air cargo, as producers rush new designs to market before competitors can copy them.

While demand is growing, cargo space is limited. Retailers and hotels pay top dollar for land next to airports, and warehouses must compete. It is often difficult to assemble tracts of land near London's Heathrow or other busy airports. But owners of strategically located distribution centers can charge top dollar in rents. Customers pay because they don't want their trucks stuck in traffic and missing planes. Hines Air Property recently spent $5.7 million to build a 77,700 sq. ft. cargo facility near London's Heathrow airport. Built on speculation, the property is seeking tenants.

Simon O'Donnell, managing director of Hines Air Property, says his company was attracted to Heathrow by monthly rents that are among the highest in the world. “The rents are more than double what you would pay for an ordinary warehouse on a road near Birmingham,” he explains.

AMB paid $23.4 million to develop a 183,900 sq. ft. facility next to Amsterdam's Schiphol International Airport. The property has been leased to Intel, which will use the distribution center to handle big shipments of semiconductors. AMB acquired a 354,000 sq. ft. distribution center for $30.3 million near Charles de Gaulle International Airport in Paris. The property is leased to La Poste, France's largest postal company.
Stan Luxenberg