Warehouse has a few faces


Tomasz Szpyt: Hello and welcome to the 7R.Blog.On podcast series, my name is Tomasz Szpyt. Together with invited experts we will talk about current trends in the warehouse real estate industry. With me in the studio today is Łukasz Jachna, board member and Chief Capital Markets Officer at 7R. Hello, Łukasz.


Łukasz Jachna: Hello, welcome. 


Tomasz: Today we're going to talk about warehouses – whether it's really such a simple property or whether a warehouse has at least a few facets to it. What could be basically complicated about a warehouse? Just ordinary boxes, racks, forklifts, ramps... Someone could say that, but is it really that simple? There are probably as many types of warehouses as there are functions that tenants would like to accommodate in them. For example, there are: multi-tenant facilities, manufacturing facilities, BTS, City Flex or even data centres. Depending on the type of facility, its investment attractiveness also changes. And here, Łukasz, I have a question for you: What are the differences? 


Łukasz: Yes, great. Thank you for mentioning all these types of warehouses we are talking about. In fact, it is not as simple as it seems at first glance. Of course, compared to other asset classes, warehouses seem to be the easiest in terms of the technological construction process itself, and they look very simple at first sight. However, all the fun is in the details, as always. These types of warehouses differ primarily in their operational nature for the tenant. Among other things, the most important aspect is the use of space that we can fill together with the tenant. We, as a warehouse developer, always try to meet the difficult and very difficult, complicated processes of our tenants because we know that this is a critical aspect of their operations. That's why 7R has its own team of architects, designers, and all this means that our products can be made to measure. At the same time, we are trying to structure these projects to make them a very attractive investment product in the international institutional investor market. This is important as we start with multi-tenant warehouses, so I will briefly sketch out what this looks like. This is a multi-let warehouse, i.e. it is designed for several tenants in one location. Since one tenant does not need a lot of space in a given location, hence we, as a developer, try to build a very diversified centre where all these tenants can be accommodated. We are talking here mostly about 5-7 tenants per centre in the size of 50,000-100,000 sqm. Many investors are interested in this type of product because they are actually buying exposure to the economy, to particular industries. At the same time, they buy themselves diversification in the form that if for some reason one of the tenants were to change its strategy, walk out, or go bankrupt, they would still be able to provide certain returns to their end investors. On the other hand, it is also interesting because today in the multi-let warehousing market we see a standard of five-year contracts. This creates a very nice flexibility for both tenants and investors, because five years is a specific period in which both the tenant and the property owner accept certain price conditions and conditions for providing space, but at the same time it is also important that after these five years, the so-called deal letting takes place, i.e. talks with the tenant about extending the space or changing the so-called tenant-mix, i.e. tenants we have in a given centre. Many investors see a lot of potential in this because it gives them a kind of unique approach in terms of the strategies they can employ. They can look at how particular tenants are developing, perhaps offer them more space as part of their core business development, or have more scenarios when it comes to selecting those particular tenants, or offer someone space for a much longer term if they see that there is such potential. This versatility of multi-let warehouses is interesting in that there are specialised funds that actually only accumulate this type of investment product. At the same time, they look much less interested in other warehouses, to which we are about to move smoothly, such as production facilities and BTS. BTS stands for build-to-suit... 


Tomasz: So tailor-made warehouses? 


Łukasz: Exactly, tailor-made warehouses, but also tailor-made warehouses in the context of very specific solutions. Then we say that there is only one tenant in one building because that is what their operation requires, critical access control or the tenant's complex production process, hence the name BTS. This is important insofar as there is much more interference here when it comes to the whole process of a tenant's core business. This is due to the fact that tenants often do not know themselves what kind of warehouse they need. It has a certain technology, which is: production, packaging & customising in e-commers and similar solutions. It is therefore very important not only to look at it from the real estate side, but also from the tenant's own operational process. Our employees from both the leasing and technical departments look at which solutions fit, how to arrange the production cycle on a given layout, i.e. the space available to a given tenant within the building, so that it suits them. At the same time, we at 7R think much more long-term and try to make these tailor-made warehouses even more versatile. On the one hand, build-to-suit warehouses are associated with a longer lease term; here we are usually referring to at least 10-15 years of a signed lease with the tenant, but of course this is a certain period agreed upon with the tenant. After this period, a discussion arises as to whether the tenant decides to renew the lease, or whether their operating business no longer fits into the type of building and wants to change the space. So even though we are talking about build-to-suit warehouses, at 7R we try to adapt them to the operations of a given BTS tenant so that, if necessary, they can be converted at a relatively low cost into the multi-let warehouse I mentioned earlier. It is important because our investors, who buy a BTS project, on the one hand buy long-term benefits from a lease agreement, i.e. the so-called cash flow which a lease generates, but on the other hand they also want to have an alternative, because BTS buildings are usually located in less obvious places as they are closer to the production location of our tenants or their core operations. Hence, at first glance these are not super obvious locations. Of course, in our cooperation with these tenants we try to encourage them to be closer to the transport routes in Poland, to be closer to the 7R hubs that we are creating both in highly developed and developing markets. In most cases this is possible. Sometimes, for technological reasons, this is not possible for the tenant, so the tenant simply chooses a particular location to which we agree and together we carry out such a project. This is a holistic approach at 7R, where on the one hand we meet our tenant's expectations, but on the other hand we think not only like a developer, but also through the eyes of an institutional investor. This makes 7R's projects highly desirable on the investment market, since it's the DNA of the so-called alternative use, i.e. different functions in the future, not only today, which gives a lot more potential investment strategies for our investors. This is a very much welcome trait. 


Tomasz: Indeed, Łukasz. You mentioned that 7R products are very desirable in the investment market. How about we move so smoothly into the City Flex category? Not so long ago, 7R closed a rather substantial deal to sell several such facilities. Could you elaborate on how this type of storage differs from, say, a big box and add a few words, sentences more about the transaction itself? 


Łukasz: Sure, by all means. Primarily last mile warehouses, also otherwise known as SBUs, or Small Business Units. In our company we have our own category called 7R City Flex, or last mile warehouses. This is our original branding, not created by accident, as we were the first developer in Poland to decide to focus on building an entire programme of City Flexes, or last mile warehouses, in major cities in Poland. We see great benefits from this because, as you have well pointed out, it is a totally different product. Firstly, the location of such a warehouse is within a conurbation. Secondly, we are placing a great deal of emphasis on public transport. Thirdly, these warehouses are a little smaller than the so-called big boxes because we are talking here about the size of a typical city flex warehouse from 10,000 to 15,000, up to a maximum of 20,000 sqm. At the same time, they are prepared for a much smaller tenant. This is a tenant who does not need to rent 50,000-100,000 sqm; this is a tenant who needs to rent 1,000-2,000 - that's the first thing. Secondly, the proportion of offices in such a warehouse is much higher, as there are more office workers than just warehouse workers. This is due to the fact that our customers are often either showrooms, e-commerce tenants or pick-up location operations for a number of players, such as DIY in the form of Euro RTV AGD, which has entrusted us with building part of its logistics network in terms of accepting returns and collections of products by private customers. This is interesting in that we require a much greater rethinking of the space in City Flex, as we want these projects to be as versatile as possible, so that the unit, which is a potential dedicated space for one tenant, is reasonably convenient for different types of operations. At the same time, as we had with multi-lets and big boxes, we also want to think like a future investor, so these divisions need to be much more universal in the future because we are actually in discussions today with the tenants with the greatest growth potential. They start today with 1,000-1,500 sqm, but as part of the development of their core business we assume that they will grow, such as the super growing e-commerce market in Poland, so in X amount of time they will need more space. Here, too, we are talking about contracts with an average duration of five years. Of course, there are exceptions for the specifics of a particular tenant, but in general the typical period is five years. These warehouses are highly sought after by investors because, firstly, this is a very common type of product among our western neighbours, while in Poland it is only just starting. There have been previous projects by different developers in individual cities, but we as 7R have actually created a programme which, as you mentioned a moment ago, we have managed to place with the Macquarie Group - this is a large investment fund specialising in infrastructure and real estate globally and in fact our cooperation has been going on for several months now. In November 2021 another project was completed. We now have 80,000 within this portfolio. This is a significant portfolio size when it comes to last mile warehouses. We are working on more locations, we see that the cooperation is very transparent, because both the investor's and 7R's expectations coincide, because we are talking about absolutely core locations, we are talking about the highest quality that can be offered to tenants and we are talking about meeting all ESG requirements in the form of photovoltaic panels, electric car chargers automatic access control and all the tenant amenities that we can present at a location, but really the most holistic approach is to be able to offer our tenants and employees public transport to these locations - something that is not possible with big boxes because they are generally located much further from the city centre. This uniqueness makes it a very unique product that we are pleased with, we develop it a lot, it requires a lot of work from our team, as we are also talking about tenants who often just start their adventure with institutional rental, so there is an educational aspect there. But with the right approach to the customer, with the right way of showing them all the advantages of this type of contract, they understand in a very short time that this is a great solution for them. We are glad that 7R's last-mile warehousing, i.e. finding tenants for practically 100% of the available space even before the completion of the construction, reflects how much such projects are needed in Poland, as well as how much tenants trust in our quality and execution of great projects. 


Tomasz: That's right, a tip-top product, a tip-top tenant, a tip-top investor... Depending on the types of warehouses, storage facilities in general, how does the profitability and risk of this type of investment change? 


Łukasz: Sure, now we're talking about these days when warehouse projects are in high demand because many institutional investors have noticed that it's no longer the ugly big box outside the city that no one looks at, but it's a key segment not only of the real estate sector but of the whole economy. Because directly a country's prosperity translates into an increased volume of international trade, storage, not to mention the whole Covid shock last year. It is interesting because we are now seeing, on the one hand, a very large inflow of capital into this asset class and, on the other hand, despite the huge supply that is now in the market and the even greater demand, there is still a lack of a good class product, as you very well put it, a tip-top product. Hence, investors are able to pay a kind of bonus to own top assets.  


As far as the distinction between our types of storage is concerned, the key is precisely the risk you mentioned, which is actually related to the length of the lease. Apart from the location, apart from the type of product, it is actually the investors today, and this is not a unified approach either, because there are some institutional investors who believe that one tenant in the aforementioned BTS for 15-20 years is of greater value to them, whose covenant, i.e. rating, financial statements they can verify today, they can check the industry in which it operates and have “peace of mind”, i.e. they buy its cash flow for the period of 15-20 years and for this they are able to pay a certain bonus. This is interesting because the bonus for this tenant is relatively high, but on the other extreme there are investors who believe that, ironically, this diversification that I mentioned earlier regarding big boxes is much more interesting because they do not invest their money in a building that has only one tenant and in case of an event that they cannot control today, they will lose all their cash flow. They prefer having this diversification in the form of several tenants and they are not afraid of this active commercialisation after the base rental period, which is about five years, so this is something they value very much. And thirdly, small last-mile warehouses, which have similar characteristics to big boxes in one respect, yet are closer to cities, which automatically makes the land price itself much higher than in the case of a big box. Then there is an additional scenario among these investors in the form of so-called alternative views, i.e. they wonder and bet whether this location on which City Flex is built today will look the same in the long term. We are not talking about five years, it is more like 10-15 years, but from their point of view there is extra value in terms of paying an extra bonus for a product like this because of the fact that they have an extra strategy in their heads. Perhaps in 15-20 years this location will not be just a storage facility, perhaps it will be office, residential...time will tell. Additionally, this specificity of even more smaller tenants on the occasion of such a programme is interesting insofar as an investor buying last mile projects bets on a very big increase in the potential of their tenants, i.e. they see that they invest in the most dynamic branch of the economy and accept the fact that they have far greater so-called active asset management, i.e. management not only of the building itself, but also of the tenants within this building in the context of maintaining them in the given last mile portfolio they buy. 


Tomasz: Right, what is the risk in the case of production facilities, not yet mentioned? Which investors are approaching this type of investment? 


Łukasz: For us, production projects are ultimately like BTS, albeit very specific, where we are not able to meet this holistic approach of ours, which is to put a BTS project on the standard envelope of a multi-let building. Then, firstly, we are talking about a lease term of at least 15 years, that is the absolute minimum, but 20 years is rather recommended. This is then a very specific building, which in fact only applies to a particular type of tenant and here the most important role is played by the financial sending of this tenant, for this is the key issue. It is taken into account as the most important factor when an investor chooses this type of product. For us this is interesting in that we see that this allows our organisation to understand the needs of our tenants even better, because a prospective tenant comes to us who has such a specific business process that the education process within our company itself is already interesting, plus something that is sought after nowadays by highly passive investment funds which don't really think about this alternative views, about the location, they only look at covenant and cash flow. They are interested in that very long time horizon that such a production product can provide. On the one hand, these are highly desirable projects, on the other hand, this is a separate category in the context of the entire logistics and industrial market in Poland. We look at it rather as an additional way to build up our competence, but also to show our potential tenants and current tenants that in fact nothing is impossible for 7R, we are able to take advantage of every demand and find such solutions that allow our tenants to be operational. 


Tomasz: Thank you, Łukasz. The warehouse market has received a real boost in recent years. This development is ongoing and very dynamic, and looks set to continue for at least a few more years. I wish you continued success in commercialising and selling warehouses. Thank you very much for the interview, and thank you for listening to the podcast in the 7R.Blog.On. series. See you in the next episode. 

Author: Łukasz Jachna

Chief Capital Markets Officer and a Member of the Board at 7R

Łukasz Jachna is responsible for building the company's investment offer, and sourcing equity for the development project pipeline. He conducts detailed analyses, creates recommendations, and manages all strategic stages of the transaction process. Łukasz focuses on the further development of sales transaction area at 7R and cooperation with current and new partners who invest in the warehouse and industrial real estate segment.

Contact: [email protected]