1

Community of Inquiry article series

Logistics industry from the institutional investor’s perspective Article 4: Renting the business premises 1. With respect to this article series This is the fourth article in Logistics Community of Inquiry series in the following four linkedIn groups:

Logistics Network Global Logistics & Logistics Executive LinkedIn Pulse Supply Chain Pro- fessional Group For a more comprehensive elucidation of purpose and objectives of a CoI (Community of Inquiry), please read the first article in this series. The first article in the series handles the investment considerations of an institutional investor by looking at macro-economic figures and analysis, logistics locations characteristics, a technical due diligence data set, and an assessment of important legal and tax issues. The second article tries to find a thesis on risk mitigation in the supply chain network structure and the possibilities for the landlord to (partly) participate in this mitigation. The third article looks into an alignment between the investor’s and logistics service provider (LSP) site selection criteria. In this fourth article we focus on three different impediments in lease agreement negotiations between the landlord (investor) and the LSP. First of all we discuss the rent level issue, followed by a discussion about flexibility in lease terms and space occupancy.

2. Talking about rent and other costs Rents in the logistics sector are given in Euro/sq m floor space per annual, and are valid for premises with heating, good communications but generally without (high) rack storages, usually located within industrial or logistics parks. Rents stated are net rents without accessory charges, and don't take incentives or other benefits into account. Rents given are nominal values. Commercial rents are differentiated into prime rents and average rents. The prime rent is defined as an average rent of the top 3-5 % of all lettings in each submarket, but because it’s an average it does not indicate the best rent level realised. The average rent is a weighted average value of all rents within a submarket. All average values are not strict mathematical means, modes or medians, but rather describe a typical, common rent level for each submarket (RIWIS, 2016). Rent is a part of the operational expenditures of a LSP, and belong in the row of other costs such as:

cost of transport activities, for each mode

cost of storage or warehousing activities

cost of time value or investment in goods in a logistics system, including the added value of transportation

cost of physical form changes required for effective and/or safe transport, storage, and handling

cost of marking, identifying, recording, analysis, as well as data transfer and handling

cost of stacking/unstacking activities

cost of added packaging required

cost of material transfer activities

cost of consolidation/deconsolidation activities

cost of information and telecommunications integration

cost of logistics system management

2

cost of unavailability of goods (when required). In general, the costs of transport activities and non-physical handling activities, such as an inventory and related time costs, constitute the majority of logistics costs (United Nations ESCAP, 2003). Cass Logistics System Inc. calculates and publishes annually national logistics cost statistics for the United States in the annual “State of Logistics” report. The report breaks down overall logistics costs into three key components: transportation costs, inventory carrying costs, and administration costs.

Figure 1: US business logistics system cost 2015 (Wilson, R., CSCMP 2016., adapted by author)

Inventory carrying costs include the cost of money (opportunity or interest), ad valorem taxes, insurance and shrinkage. Inventory carrying costs include those costs that vary with the level of inventory stored. They can be categorized into the following four groups:

Capital costs

Inventory service costs

Storage space costs

Inventory risk costs. Rent is included in the group storage space cost. For the Cass report the storage space costs are incurred at four types of facilities:

plant warehouses

public warehouses

rented (leased) warehouses

company-owned(private) warehouse. So the rent is included in the 143 Billion $ (33 % of total system costs). Area Development (2015) breaks down the costs on a more detailed scale, and the outcomes of their 24th Annual Corporate Survey is confirmed by another survey of Establish, Inc. / HWD & Grubb & Ellis Global Logistics, cited in Rodrigue, J-P. (n.d.). Last but not least Jones Lang LaSalle (2015) conducted their own research and the outcome is in line with the conclusions of Area Development and Rodrigue.

3

Figure 2: Splitting up logistics industry costs by main categories (Jones Lang LaSalle, 2015)

The conclusion out of these survey is that rental costs are approx. 4,3% of the total operating supply chain costs in the logistics industry. Impact of rent increase or decrease should therefore be of minor importance to the logistics provider. In practice the opposite is true, leading to idiosyncratic discussions between LSP and landlord. This is the more astounding if you look at the latest combined 2014 logistics industry survey of PWC/FTA (Freight Transport Association). The report explores influences the business should take into account as they deliberate, plan and invest for the future. One of the extensive surveys that was conducted is an inventory of the main issues of concern to CEOs across the globe.

Figure 3: Main issues of concern to the logistics industry (PWC/FTA, 2015)

There is no evidence that the logistics industry sees future rental levels as a dangerous or disruptive factor in their business. This endorses the minimal importance of rent costs in the total supply chain, as stated in fig. 2. Another part of the survey concentrated on rating the risk and importance of a range of issues the CEOs were likely to encounter. No surprise that, similar to the results in fig. 3, rental costs were of no influence. Oil prices, economic growth and employees are seen as the most important issues.

4

Figure 4: Main issues of concern to the logistics industry (PWC/FTA, 2015)

Rental costs are very often a big part of the discussion between landlord and LSP when negotiating rental contract conditions, which raises the question that there should be other underlying reasons to put the focus on these costs. Perhaps an answer can be found when looking into the cost structure of a LSP for getting the goods delivered to his customer.

3. Logistics costs analysis Bokor, Ph.D. (2012) conducted a very extensive study on cost calculation models for LSP. Bokor states that it is essential to gain reliable and accurate costing information, where current traditional approaches may not be sufficient to reach this aims. According to Bokor this is connected to nowadays complex and heterogeneous logistics service structures, who tend to become more intricate on a fast pace. This is also concluded by Christopher (2011) , who states on p.99 of his book Logistics and Supply Chain management: “Because logistics management is a flow-oriented concept with the objective of integrating resources across a pipeline which extends from suppliers to final customers, it is desirable to have a means whereby costs and performance of that pipeline flow can be assessed.” The logistics industry is not very keen on revealing and sharing the way they calculate their costs, likely due to competitive considerations. Getting a grip on a transparent and multi-usable cost calculation model seems therefore impossible. The primary method of measuring logistics costs is, according to a survey of Gilmore (2006):

40 % costs are taken as a percent of sales

25 % in absolute cost

16 % cost by some unit of weight (hundred weight, kilograms, etc.)

11 % cost per some sold measure (case, unit)

8 % uses “activity-based costing” as the primary measure. To make it even more complicated process-based cost accounting is introduced (DHL, 2008) where following steps are taken:

Identification of the actual causes of the output and cost volume (process factors, reference values and cost drivers). So process-based cost accounting also includes, in addition to

5

employment, the array of variations, complexity of the products and production, and the

size of the contract as cost factors

Determine process quantities by counting the number of material orders, material deliveries, etc. Process cost-unit rates can be determined by dividing the costs allocated to a process by the related process quantities

Identified, functionally related sub-processes are added to main processes in a manner that extends across cost centres.

Trying to get a meaningful thesis on rent costs by scrutinising the total supply-chain is pointless. Instead, for the further part of this article the basic assumption is, that logistics warehouse costs are considered to be the costs of managing a skid or pallet in 3PL storage. This in the absence of comparable other calculation methods and a possibility to determine the influence of rent costs out of the total supply chain costs. The example below illustrates a rough calculation of pallet position pricing.

So within the warehouse costs only (included in the carrying costs, according to Wilson 2006) rent costs do have a significant influence, as the example shows (22% of total warehouse costs). In academic literature there’s no empirical proof for this ratio estimate, but it would be an important key ratio for an institutional investor when determining the rent for the warehouse.

4. Adjusting rent costs Continuing with the former warehouse example, a simple table can be compiled showing the correlation between reducing rent costs and its influence on total warehousing costs. Assumptions are a surface of 15,000 sq m and a starting rent of 70 € sq m per annual. See table 1. However when an institutional investor gets involved, adaptation of the rental price influences the total annual cash-flow and thus the purchase price the investor is willing to pay. If we extend table 1 with the purchase price the investor is willing to pay against a certain annual income, we see a huge reduction of the purchase price. The assumption for table 2 is that a capitalisation rate of 15 (yield approx. 6.5) is in conformity with market circumstances. The purchase price is represented as a rounded figure and follows for obvious logical reasons the same reduction as the rent price.

A relative simple static storage facility with little in the way of capabilities, at the high end for a 15,000 sq m warehouse, internal height of 14 meters, give you the following annual numbers: 70 € sq m lease costs x 15,000 sq m = 1,050,000 € 30 € sq m operational expenses (utilities, insurance, taxes, etc.) = 30 x 15,000 sq m = 450,000 € Total static operational costs 1,050,000 € + 450,000 € = 1,500,000 €. Labour costs: number of workers 30 employees x 40 € per hour, daily costs 30 employees x 8 hours x 40 € = 9.600 € x operations 6 days a week = 57.600 € weekly, yearly labour costs 2.995.200 €. If 10 electro-forklifts are leased, factor in 600 € per month per forklift = 6,000 € x 12 months = 72,000 € Estimate for general and overhead costs 33,000 € p.a. Total active expenses 2,995,200 € + 72,000 € + 33,000 € = 3,100,200 € This warehouse would run its operator 4,6 million € (rounded) per year. If the facility can store 40,000 pallets, they would cost roughly 115 € a year per pallet position. Note: this is a very high estimate, assuming the highest possible cost per pallet position.

6

Rental cost Yearly Percentage Total ware- Reducing

sq m p.a. rent of initial rent house costs wareh. costs

70 1.050.000 100% 4.700.000 0%

68 1.020.000 97% 4.600.000 2%

66 990.000 94% 4.500.000 4%

64 960.000 91% 4.300.000 9%

62 930.000 89% 4.200.000 11%

60 900.000 86% 4.000.000 15%

58 870.000 83% 3.900.000 17%

56 840.000 80% 3.800.000 19%

54 810.000 77% 3.600.000 23%

52 780.000 74% 3.500.000 26%

50 750.000 71% 3.400.000 28%

48 720.000 69% 3.200.000 32%

46 690.000 66% 3.100.000 34%

44 660.000 63% 3.000.000 36%

42 630.000 60% 2.800.000 40%

40 600.000 57% 2.700.000 43%

Table 1: Correlation between rent and total warehouse costs (source: author)

Rental cost Yearly Percentage Total ware- Reducing Purchase Percentage

sq m p.a. rent of initial rent house costs wareh. costs price of initial price

70 1.050.000 100% 4.700.000 0% 16.100.000 100%

68 1.020.000 97% 4.600.000 2% 15.600.000 97%

66 990.000 94% 4.500.000 4% 15.200.000 94%

64 960.000 91% 4.300.000 9% 14.700.000 91%

62 930.000 89% 4.200.000 11% 14.300.000 89%

60 900.000 86% 4.000.000 15% 13.800.000 86%

58 870.000 83% 3.900.000 17% 13.300.000 83%

56 840.000 80% 3.800.000 19% 12.900.000 80%

54 810.000 77% 3.600.000 23% 12.400.000 77%

52 780.000 74% 3.500.000 26% 12.000.000 75%

50 750.000 71% 3.400.000 28% 11.500.000 71%

48 720.000 69% 3.200.000 32% 11.000.000 68%

46 690.000 66% 3.100.000 34% 10.600.000 66%

44 660.000 63% 3.000.000 36% 10.100.000 63%

42 630.000 60% 2.800.000 40% 9.600.000 60%

40 600.000 57% 2.700.000 43% 9.200.000 57%

Table 2: Influence purchase price vs. diminished cash-flow (source: author) This simplified elaboration becomes a bit more complicated if you add the role of a warehouse developer or contractor to it. A warehouse of approx. 15,000 sq m will generate construction costs of approx. 300 € sq m, so in total 4.500.000 €. With a needed footprint of 30,000 sq m land to put the building on (50 % built area), estimated purchase price of the plot will be 30,000 sq m x 100 € sq m = 3,000,000 €. The total costs for the developer/constructor are ,500,000 €. To generate the most profit out of a sale of the premises the developer will, for sure, not close down on a rental price of 40 € sq m p.a.

7

although this price could be in conformity with market circumstances. By simply giving the logistics tenant incentives by means of rent-free periods or cash payments the tenant can be persuaded to close down the rent on a higher level as market conformity. But incentives disappear in the total operation of the tenant and within a year the logistics tenant faces too high warehouse costs in comparison to what he earns out of his operations. In the end this leads to never ending future discussions on the rental level between landlord and tenant. Despite this circumstances the rent will develop in a modest way, as below aggregated graph demonstrates. What is important though is the expectation that this modest rent growth will be sustained throughout the foreseeable future, with growth strengthening slightly in the years to 2017 before slowing a little from then until 2020. So flexibility from the side of the institutional investor regarding rental prices could be of an advantage for both parties.

Figure 5: Modest growth of logistics rents in Europe (source: CBRE, 2015)

5. The rental period Another important part of the lease agreement between the landlord and the 3PL is the duration of the lease agreement. For an institutional investor the most obvious method of investing in real estate is for the long term. This implies that, due to the investors duties against its share and stakeholders, a steady cash-flow is needed. With offices, hotels, retail and parking garages a long-lasting cash-flow is most of the time guaranteed. With logistics housing there is a different approach. The independent decisions of consumers and companies cause fluctuations of the order flows and material flows. Varying customer behaviour, technical development and changing demand generate systematic variations of these flows. The dynamic of the flows determines and changes the logistic networks. In the short term, swelling, shifting and decreasing flows force the actors to adjust the static and dynamic capacities of the logistic stations and transport connections (Gudehus, T. & Kotzab, H., 2012). Because of this market dynamics in the supply chain LSP (with some exceptions), conclude on service contracts between them and their clients that often have a duration of 3 to 5 years maximum. Only in some exceptional trusting business relationships the contracts can last 10 years or longer. Very often within the timeframe of a 3 to 5 year contract the LSP gets a bit more management fee in the beginning to start up the business, where the fee tends to reduce the longer the contract lasts.

8

In general outsourcing to a LSP takes place because of the advantages and opportunities the clients in the supply chain anticipate (Gudehus, T. & Kotzab, H., 2012):

higher limit performances and larger store capacities

improved service quality due to professionalism and specialization

higher flexibility by extensive resources for several customers

lower costs due to high efficiency and better utilization

favourable wages and salary structures due to other tariff agreements. Competition, market turbulence, cost savings and flexibility put the relationship between landlord and tenant under quite some strain. Especially the difference between the landlord’s assumption on lease agreement durations and what in real logistics life is practice, give rise to incomprehension and discontent on both sides. So on the one hand the institutional investor might need to adapt his portfolio performance expectations, where by no means this implies that performance will break down. On the contrary, by being flexible in the relationship with the LSP, logistics real property can easily outperform other asset classes such as offices, hotels and retail.

Note: f = forecast Figure 6: Prime logistics total returns Europe 2015-2019 (source: Deutsche Asset & Wealth Management, 2015)

Figure 7: Estimated Yield development Europe to 2020 (source: DekaBank, 2015)

9

Figs. 6 and 7 clearly indicate the attractiveness of the logistics and light industrial market as an asset investment class. To maintain a steady growth in logistics portfolio performance next to the rental level, a joint effort with LSP with regards to lease agreement duration should be considered by the investor. Most of the time providing the LSP with a lot of flexibility in duration (and sometimes in available space) means the LSP enters into a long-years relationship with the landlord and tedious discussions about the rental level can be avoided. The investor should not forget that LSP have a huge bargaining power, due to their scale, global business importance, resourceful network, market reconnaissance and in-depth body of knowledge regarding supply chain processes. Appendix 1 with this article gives an overview of the 20 largest 3PL worldwide (ranking 2011). The total logistics industry turnover in 2011 amount to 981 Million Euro (Roland Berger Strategy Consultants/Barclays, 2014), so the logistics sector has a huge economic importance and impact.

Figure 8: Importance of the global logistics industry (source: Roland Berger Strategy Consultants/Barclays, 2014)

6. Space flexibility Flexibility within logistics management is crucial to maintaining efficiency and accuracy in shipping processes. ... Flexibility refers to the scalability and adaptability within a given system to improve the effectiveness of shipping processes (Robinson, 2015). Warehousing providers are permanently seeking ways to increase flexibility, improve inventory control, manage costs, and streamline the supply chain. They try to achieve this by supporting manufacturers and other clients through:

Shared space environments to accommodate shipping peaks and valleys by balancing multiple manufacturers' requirements with complementary surges

Bring functions such as secondary packaging closer to the customer mainly to delay product configuration until the last minute to meet current demand. This takes nowadays place in the warehouses

Move products more efficiently and cost-effectively by using cross-docking — moving product directly from receiving to shipping with little or no inventory and minimal handling. The process is resurfacing as a way to take costs out of the supply chain, accelerate inventory velocity, and improve service levels.

The investor has to keep in mind that demand focusing on better quality modern space, doesn’t mean that organisations are not under pressure to reduce costs. One could argue that occupiers recognise that paying more for the right kind of building in the right location can produce greater cost savings and efficiency gains across the business.

10

This means that the winner in providing logistics housing is the investor who offers the sector short and flexible solutions which are negotiable in short timescales. This is particularly true of specialist logistics firms but some manufacturers, once tolerant of older, smaller buildings in sub-optimal locations with lower rents, are now also becoming less willing to take this kind of space. Again this is in contradiction to what institutional investors are used to. But in the end flexibility in offering storage space and lease agreement duration will lead to a steady long-lasting relationship with the LSP, where the main issue will not be the rental price anymore. Offering to a large extent full flexibility, even tailored to the LSP, will bring the logistics industry more profit as a reduction on rent price.

7. In conclusion Although no conclusive argumentation can be found on the influence of rent costs in the total operations of the logistics supply chain, it is arguable that rent is a substantial part of the warehouse costs, and thus will influence the profit of the 3PL, being it negative or positive. By not openly sharing data with regards to costs and profits of a 3PL operation, institutional investors will always be very reluctant to discuss the rental level. A good starting point could be more transparency in the relationship between the institutional investor and the logistics provider, particularly openness regarding the cost structure in the supply-chain. This would be an instrument to have a better alignment of the rental level. Next to the rental level two other important negotiation points between parties are flexibility in the duration of a lease agreement, and flexibility in provisional disposal or absorption of space. By emphasising duration and space flexibility, most probably an institutional investor can avoid cumbersome discussions on the rent level.

The questions to the Community of Inquiry

1. Do you think the conclusion on emphasising flexibility in lease duration and space take-

up/disposal, thus avoiding complicated rental price discussions, is sound, from the viewpoint of a LSP?

2. Is there missing any particular issue in this article regarding obstacles that hinder the process of

concluding a lease agreement between the investor and the LSP?

11

About the author

Jan van den Hogen is an inspiring senior real estate professional with a strong affinity towards logistics and light industrial real property. The necessary management

skills are present and currently Mr. van den Hogen heads the Tenant Relationship Management Logistics department for Deka Immobilien GmbH, a subsidiary of DekaBank, one of world's largest institutional investment banks. Through continuous education Mr. van den Hogen constantly extends his body of knowledge in the field of activity.

To share knowledge, professional aptitude, market insights and managerial expertise, he is a part-time lecturer of MSc (Master of Science) students in the field of FREM (Facility and Real Estate Management) at various universities. His professional network ranges from facility-, property-, asset- and portfolio managers to political decision makers, CEOs of private, public and institutional real estate investment companies, agents of globally represented companies and worldwide operating location and expansion managers from all kinds of branches.

Contact data: Business e-mail address: jan.vandenhogen@deka.de Business websites: https://www.deka-immobilien.de/en/01/01/index.html http://www.westinvest.de/ Private email address: cursus.leider@upcmail.nl

(use Ctrl+Click to open links)

Many thanks go out to Mr. Locke McKenzie, who is always willing to help me with the English language and grammar in my articles. As a journalist, proofreader and translator, he works tirelessly to ensure my content is clear, readable, and refined.

Contact data:

(use Ctrl+Click to open links)

12

Reference list: Armstrong & Associates, Inc. (2014). Top 25 Global Freight Forwarders: Largest Providers by 2013 Gross Revenues and Freight Forwarding Volumes. Madison, United States. Bokor, Z. (2012). Cost Calculation Model for Logistics Service Providers. Budapest University of Technology and Economics: Department of Transport Economics, Budapest, Hungary. CBRE (2015). The Changing Industrial & Logistics Landscape. CBRE Viewpoint Series, December 2015, EMEA Research, London. Christopher, M. (2011). Logistics and Supply Chain Management (4th Ed.). Pearson, Inc. /FT Press, New Jersey, United States. DekaBank/PMA (2015). Europe Investment Forecasts: Autumn 2015. DekaBank, Frankfurt. Deutsche Asset & Wealth Management (2015). European Real Estate Strategic Outlook. Deutsche Bank, Chicago, United States. DHL / Technical University of Darmstadt (2008). Process-based Cost Accounting. DHJL Logbook, Discover Logistics article series, 2008. Feemster, T. & Tillman, J. (2010). Inbound-Outbound Logistics Cost Determines Location Decisions. Area Development. Halcyon Business Publications, Inc. Westbury, NY, United States. Retrieved on 17 January, 2016 from: http://www.areadevelopment.com/corpSurveyResults/july2010/logistics-cost-location-decision4901.shtml Gilmore, D. (2006). The Right Way to Measure Logistics Costs? Supply Chain Digest, March 10, 2006. Retrieved on 23 January, 2016 from: http://www.scdigest.com/assets/FirstThoughts/06-03-10.cfm?cid=103 Gudehus, T. & Kotzab, H. (2012). Comprehensive Logistics (2nd Ed.). Springer-Verlag, Berlin-Heidelberg. Jones Lang LaSalle (2015). Navigating your supply chain from strategy through implementation. Supply Chain & Logistics Solutions Report. Jones Lang LaSalle, IP, Inc. Chicago, United States. PMA/DekaBank (2015). Europe Investment Forecasts: Autumn 2015. AMI Presentation PWC/FTA (2015). The Logistics Report 2014. Freight Transport Association Limited, Kent. RIWIS (2016). About the Data: Definitions and Additional Information. RIWIS Online. Retrieved on 17 January, 2016 from: http://www.riwis.de/online_test/en/info.php3?cityid=&info_topic=gewerbe Robinson, A. (2015). Strategic Logistics Management: The Importance of Flexibility. Cerasis, Logistics Transportation Management Series. Retrieved on 24 January, 2016 from: http://cerasis.com/2015/11/13/strategic-logistics-management/. Rodrigue, J-P. (n.d.). The Geography of Transport Systems: logistics costs breakdown. Hofstra University, Hempstead, NY, United States. Retrieved on 17 January, 2016 from: https://people.hofstra.edu/geotrans/eng/ch5en/conc5en/logistic_costs_breakdown.html Roland Berger Strategy Consultants/Barclays (2014). Global Logistics Markets. Roland Berger Strategy Consultants GmbH, Barclays Bank PLC Frankfurt Branch, Munich, Frankfurt am Main.

13

United Nations ESCAP (2003). Commercial Development of Regional Ports as Logistics Centres. United Nations Publications, Economic and Social Commission for Asia and the Pacific, Bangkok. Wilson, R., Council of Supply Chain Management Professionals CSCMP (2016). US State of Logistics Report 2015. Cass Logistics Systems, Inc., Grand Rapids, MI, United States.

14

APPENDIX 1: Top 25 Global Freight Forwarders Largest Providers by 2013 Gross Revenues

Logistics Service Provider

Gross

Revenue (US$ Millions)

DHL Supply Chain & Global Forwarding

31,432

Kuehne + Nagel

22,587

DB Schenker Logistics

19,732

Panalpina

7,293

Sinotrans

7,738

Nippon Express

17,317

Expeditors International of

Washington

6,080

SDV (Bolloré Group)

7,263

8,517

15

CEVA Logistics

DSV A/S

8,140

Hellmann Worldwide Logistics

3,433

UPS Supply Chain Solutions

5,492

Kintetsu World Express

2,718

UTi Worldwide

4,441

Damco

3,212

Pantos Logistics

2,546

Yusen Logistics

4,042

C.H. Robinson

12,752

16

Kerry Logistics

2,575

Agility

4,415

Geodis

5,828

Toll Holdings

6,266

Logwin

1,620

NNR Global Logistics

1,745

Source: Armstrong & Associates, Inc. (2014)