13 February 2023
Race for Space
How to manage risk in an ultra-competitive logistics market
There has been an unprecedented demand for well-located logistic centres and assets following COVID-19, as the sector has ridden the wave of the e-commerce boom. Western Europe’s e-commerce sales have grown 128% since 2015; pandemic retail sales rose by an average of 31.1% in 2020 and a further 14.1% in 2021. Distribution networks are now in a constant state of adaptation as they strive to meet customers’ 'same day' demands.
Logistics space take-up persisted during early 2022 with the highest H1 on record, up 9.4% year-on-year. Nevertheless, pure online retailers accounted for less than expected (13.6% in H1) – now there is a more even spread of sectors taking logistics space, including third-party logistics (27.6%) and manufacturing (15.1%).
Distribution networks are now in a constant state of adaptation as they strive to meet customers’ 'same day' demands.
Consequent supply chain challenges have prompted businesses to onshore manufacturing operations and hold more inventory closer to customers. According to Savills Logistics Census 2021, the most significant pandemic-related change anticipated is the shortening or reshoring of supply chains to mitigate risk.
Availability of space has become a critical issue, and the European vacancy rate average is just 3.3%. A shortage of prime stock has applied upward rental pressure, with an average increase of 5.9% over the past 12 months, led by London and Warsaw (20% each).
Developers have faced continued pressure to create new spaces but have struggled to step up construction. Inflation, the rising costs and/or lack of availability of land, materials and labour and onerous regulation and planning requirements have all made existing assets more valuable. This shift has opened exciting investment opportunities; there is currently a wealth of deployable capital, or “dry powder”, available, and some investors are sitting on large funds waiting for the right assets. Dollar and overseas buyers have an even stronger hand given the relative strength against the pound/euro at present.
New market entrants in the past 24 months have generated fierce competition and a high level of investment volumes, whilst yields have continued to compress. Nevertheless, owners are still confident of the long-term fundamentals that underpin the market even at these lower yields.
A more pressing problem is the rapidly rising cost of debt, particularly for those heavily-leveraged owners and/or those who need to re-finance. The challenging environment may force them to sell, creating the potential for plenty of opportunistic acquisitions as we move into 2023.
As the market shifts, effective risk management can play an increasingly important role in managing insurance spend and responding to macroeconomic pressure.
Construction
Full construction details are key to an insurer accepting a risk at the best possible terms (i.e. policy coverage and pricing). The hardening insurance market, which was exacerbated by COVID-19, has regained some stability, and given a number of insurers a competitive edge. What has borne out of the hardening market (and prior high risk events such as the Grenfell tragedy) is a firm change in insurer attitude; historically many underwriters didn't require nearly such extensive information about the assets they were insuring (certainly if an asset was part of a large portfolio insured).
Insurers now drill down into the detail, and information is the key to delivering successful insurance outcomes for our clients. When we talk about information, this is typically centred around what is known as COPE information –standing for: construction, occupation, protections and exposures – for every client and risk.
Particularly in relation to construction information, one critical area here is the availability of detailed technical specifications for cladding and insulation material, the use of which is common for logistics assets due to their structural make-up. A host of materials are available, ranging from non-combustible to highly combustible materials. For insurers to model and accept the risk, they need to understand the materials used (including the relevant approvals in regard to the fire rating) – otherwise it is more or less impossible for the insurer to differentiate between what could be a minor or total loss in the event of a fire. Without this information insurers will likely look at the worst case scenario, which would not provide competitive premium outcomes for landlords and ultimately tenants.
Building regulations and standards differ from territory to territory across the UK and EEA. The EU has harmonised the fire testing and classification for a number of building products. However, regulations for the entire structure and the requirements for fire safety are the responsibility of each individual EU Member State. They determine their fire safety level, and can use varying degrees of products with differing levels of combustible material that, used together to complete a structure, correspond to the overall fire classification requirements. Where these disparities exist, early engagement with a broker to discuss the material used, and working with insurers to ensure risk engineers are comfortable is essential.
Logistical centres typically have a large footprint in terms of square footage, which makes them ideal candidates for the installation of solar panels or photovoltaics (PV). PV roof panels on the roofs can be fantastic for ESG credentials and potentially selling back energy to the grid. Alongside these benefits, however, there are risks to rooftop solar that any property owner should consider from the earliest stages of a project to ensure adequate insurance cover is available. When it comes to retrofits, property owners and developers should also be aware that rooftop solar will change the risk profile of existing structures. Prompt consideration of the insurance implications is critical if uninterrupted insurance cover is to be maintained.
Occupancy
Logistics centres can be used for a wide range of activities. Standard distribution tends to be relatively low risk due to the nature of the operations, particularly with cross dock assets. Nevertheless, there is an extensive range of potential occupancies, which all present particular risks in their own right.
As the cost of business increases (through inflationary pressures and the rises in fuel and labour costs), it is possible that goods will be stored in a property for longer. Across sectors, it is imperative that sound risk management is in place; insurers want to understand what the tenants are doing and how they manage their risk.
Whilst there are many varieties of occupancies which would have specific risk features, two examples can be given here:
- In manufacturing, hot works raise the risk of fire exponentially, whether this is through metal works or carpentry, which increase exposure to fire related losses. The storage and quantity of flammable materials (including gas containers) would also be a key risk factor, so risk management information and detail on how such materials are stored, the quantity on site, and how they are used, is key.
- Though food is not generally a combustible material, the way produce is stored is a considered risk factor should there be a need for cold storage units, which may require a form of insulation, some of which could include a potentially combustible material.
Importance of robust Fire and Security Protection
Regardless of how the structure is built or occupied robust fire protections is key for securing the best possible insurance terms. Information on sprinklers (if they are present) is vital. Furthermore, if there is racking, to what height does it go? Will this impact/reduce the sprinkler coverage? Insurers need to have confidence the suppression systems are able to function appropriately. Are clients aware of innovation in this field, such as the use of racking systems with built-in sprinklers?
Another exposure to consider is that, historically during challenging financial climates, levels of opportunistic crime tend to rise. Insurers partly review the risk based on postcode, and crime statistics and cybersecurity are influential. Insurers will ask: what security measures are in place – CCTV, security guards, regular patrols, what standard of lock? What's the perimeter of the building? How is that secured?
Successful investors in the logistics space utilise local knowledge when making investment decisions; they understand the value of a broker who has an in-depth understanding of the sector and a strong network of local experts and relationships in those corresponding territories. An experienced and specialist broker such as Gallagher, with its extensive knowledge of and connections in the real-estate insurance market, is an invaluable ally in this process, and can assist in obtaining adequate coverage, as efficiently and cost-effectively as possible.
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