By
Anshul-Singhal
Anshul Singhal

Business and consumer behaviour trends witnessed an everlasting evolution in 2020. An unprecedented migration took place online, with 700 million internet users across the country and an exponential adoption of e-commerce due to nationwide lockdowns making warehousing an obvious beneficiary.  

The year 2020 will be heralded as a period when the logistics sector not only came into the limelight but began to get recognised as an “essential services” sector forming the lifeline of the country’s GDP.  

Many factors resulted in the sector’s aggressive metamorphosis in 2020. Along with a favourable regulatory ecosystem (GST, National Logistics Policy, and others), Covid-19 amplified the sector’s growth potential via an increased focus on Grade-A warehousing. 

An accelerated and ubiquitous adoption of e-commerce and same/next-day delivery, decentralised demand due to this rapid digitisation, and the consequent higher penetration of e-commerce and omni-channel retail in hitherto under-developed and under-serviced locations further secured the warehousing and logistics sector’s status as one of the most crucial lifelines.

Rapidly, most offline traditional retail stores will have an online version, making the in-store shopping experience more holistic and ensuring that lack of shelf inventory is made up by warehouse inventory -- increasing their customer loyalty base in this process. 

With various forms of electronic payments, online wallets and availability of easy consumer credit, consumers now expect service at the click of a button both online and offline. Quicker delivery time has now become a key factor in capturing market share. 

Companies like Amazon are not only acquiring large automated warehouses on lease, but have also globally started acquiring a fleet of airplanes, multi-billion dollar warehousing robotic companies, and are experimenting with drone deliveries just to be able to reach customers faster. 

Retail giant Walmart’s move in India that saw the purchase of Indian online marketplace Flipkart is a clear message as to what the future holds. The sentiment change in buying behaviour across the country will not only increase the need for more storage, but also multiply the points of storage. 

There is clear awareness of the need for increased decentralisation and more facilities with the ability to hold more stock, forcing organisations to re-think their supply chain philosophy from the ground up. 

The glaring underlying fact is that e-commerce simply cannot exist without warehousing, and warehousing cannot remain the same as it has in the past. 

Warehouses are going to get smarter, more automated and remain essential as they continue to ship thousands of packages every hour. 

This also further points to the fact that warehouses will need to continue to evolve and become even more capital-intensive, and will only be able to be built by developers with sizeable balance sheets, land as well as construction expertise and -- most importantly -- a very good understanding of the needs of their customer along with the end-consumer. 

E-commerce as the tipping point

As numbers go, e-commerce warehousing demand had been recording healthy growth in the last few years anyway, with its share in warehousing demand increasing from 14% in 2017-18 to 23% in 2019-20. The shift in buying behaviour will further increase the share of e-commerce in warehousing demand in the medium to long term. 

India faces a fundamental lack of Grade A warehousing with only  approximately 100 million square feet (sq ft) of modern Grade A warehousing stock. As warehouses are typically used to store outbound packages at different stages of the value chain, order fulfilment centres and hubs require Grade A facilities for processing. 

I have elaborated further on Grade A warehousing later in the article.  According to the Knight Frank India Warehousing Report 2020, 41 million sq ft of warehousing stock was absorbed in 2019-2020 in 8 cities and, out of this, 23% was taken up by e-commerce companies, which amounts to about 9.5 million sq ft. 

As per industry estimates, the total e-commerce GMV stands at approximately 30 billion sq ft (Bain report) with an approximate 30% year-on-year growth (RedSeer). 

If this trend is projected to 2025, when the e-commerce sector is expected to grow to $120 billion, we estimate that e-commerce companies will proportionately require at least 25 million sq ft of Grade A warehousing stock in 2025 across the country.

While the focus in warehousing currently is centered on e-commerce and 3PL (third-party logistics) companies, industrial growth is important for a more well-rounded demand profile. 

A cocktail of policy initiatives, which the government is already undertaking, and a recuperating economy, should do the trick, adding to the overall warehousing demand.

Warehousing gets an upgrade

The impact of warehousing has not gone unnoticed. High demand, low vacancies, limited approval and development risk, a shorter development period relative to other real estate asset classes, combined with attractive development returns and stable long-term yields backed by blue-chip tenants -- have collectively made the sector’s risk-reward dynamics extremely attractive for investors looking to divert their incremental capital for stable yet lucrative growth. 

Pre-covid “smart money” from large institutional investors had already begun flowing into warehousing assets globally as well as in India, with institutional investors having committed over $6 billion to the Indian warehousing real estate sector over the last 2 to 3 years. 

Post-Covid, warehousing continues to look even more attractive as it is expected to be relatively immune to shocks in the short term. 

In the mid to long term, it will continue to be attractive with accelerated and continued e-commerce penetration and widespread increases in inventory levels across industries in anticipation of supply disruptions, driving a  spike in warehousing demand. 

The natural progression in warehousing demand is and will continue to be propelled by a tectonic yet fundamental shift in the end-consumer’s demand pattern. 

With the advent of social media, the new customer is not only concerned about timely deliveries but is increasingly focused on high quality with every purchase, and is more aware and uncompromising about his/her options. Quality packaging, ensuring zero product damage and free returns without hassles, is now the baseline expectation that customers have.

The fulfilment of this need requires businesses in India to not only rapidly increase their warehousing real estate, but also adapt to higher quality standards. 

Facilities need to translate to faster, error-free throughput while maintaining health and safety regulations, and ensure that operations remain environmentally sustainable and compliant with statutory norms, in line with global standards and mandates. 

In a cost-conscious economy like India, with one of the largest-growing consumer bases in the world, this graduation is only possible if there is manufacturing and consecutive good-quality warehousing, at scale. Operating at such scale allows for higher productivity, cost efficiencies and, eventually, more ‘Atmanirbhar’ prosperity. 

The government, growing cognisant of such primary shifts, is also enforcing minimum quality standards, most of which can only be achieved with in-city/multi-storey/periphery and new-age Grade A warehousing. 

Grade A facilities are essentially modern, large-format logistics parks that offer compliance, safety, hygiene and enable automation. These are strategically located in close proximity to transport hubs and infrastructure arteries, enabling high throughput and low transportation costs. 

These facilities are high on specifications allowing for timelines that modern delivery businesses mandate, and are built to enable a high-level automation in the future. 

The delivered build quality is extremely important, as the cost of repairs always turns out to be expensive and disrupts operations. The warehouses and amenities in these modern logistics parks are designed for high throughputs and turnovers, undergo regular maintenance, and are built to last for at least 30 years. 

Moreover, they are equipped to accommodate future expansion and consolidation of operations in the same park, allowing for efficiency of scale. Naturally, these facilities can be built only with sufficient expertise, experience and a sizeable infusion of capital.

As the emphasis on speed, quality and cost keeps rising, these Grade A facilities will become commonplace and replace the older, less-efficient vestiges of the erstwhile godown. This is already the case in most Tier-I cities. 

With the emergence of many online-only brands in Tier-II and Tier-III markets, which need warehouse space but no retail space, demand for Grade A warehousing is also growing at an alarming rate, even in the hinterland. 

There is a lot of conversation surrounding the rise of the warehouse rental cost. Let’s put that in perspective -- since warehouse storage costs form approximately 8% of the overall logistics cost, better quality assets can increase the operational efficiency at a smaller percentage of overall cost. 

Thus, an approximate 5% increase in storage cost to provide a better quality asset would give the customer an almost 25% improvement in operational efficiency. 

This 25% operational cost-efficiency improvement will lead to a good operations cost reduction lever giving a 4x ROI (return on investment) over the increased storage cost, making good quality assets extremely viable in the future. Consequently, there is a vast demand gap waiting to be fulfilled by Grade A warehouses. 

The challenges

Technically, as warehousing gains traction as a viable asset class, the sector will see an increased interest from local and institutional developers running the risk of oversupply.  

However, warehousing is a focused business, which requires a specific team and a certain type of mindset to manage the business, being able to invest all the capital upfront, with returns and yield manifesting much later in the development. 

Expertise in land acquisition, approvals that differ from state to state, experience of delivering towards the unique requirements for a diverse customer base, master planning for complex logistics, delivery of high quality building on time, and building deep client relationships are challenges new developers must face while entering this business. 

The entry barriers are thus high, with sizeable capital requirements upfront, a large pan-India capability, and deep understanding of the customer requirement and their dynamic needs. 

These factors make it highly unlikely that the sector will see an oversupply or too many players in the market. 

A more pressing sectoral challenge is the deploying of capital vis-a-vis sourcing the right land for projects. Land acquisition remains the Achilles’ heel of warehousing development, requiring large parcels of contiguous land with clear legal title. Successful land acquisition for the creation of large-scale Grade A logistics parks is akin to a competitive game of chess, requiring a deep understanding of all the moving parts.

For instance, land acquisition for warehousing in Tier-I cities is only possible around unplanned corridors, where one can co-exist with affordable housing projects and where development costs can be kept affordable over a long period of time. 

City-centric micro markets make specific pieces of land sought-after and overvalued, whereas tenanted land, which is unavailable for undertaking in metros and Tier-I cities, can lead to longer timelines for both acquisition and construction, creating a strong case for multi-storey warehousing. 

The acquisition strategy for Tier-II and Tier-III cities, as part of which firms will also look at backup storage options away from highly affected Tier-I cities, is completely different. 

While land parcels in these areas remain ripe for development and are definitely where the future of Grade A warehousing lies, they must be strategically conceptualised and built with expertise to achieve an attractive return at competitive rentals.

The Indian warehousing decade

In 2021, as investors grapple with rebalancing their portfolios to manage risk in this post-pandemic world, warehousing presents one of the few bright spots in an otherwise difficult real estate investment scenario, since it is one of the few asset classes which provides both attractive development returns and stable long-term rental yields. 

Further, it is relatively de-risked from an approvals and construction risk perspective given a shorter development cycle (usually 9-12 months ground up) and less construction complexity relative to other segments of real estate like residential, office, retail, etc. 

With this in mind, the India warehousing story looks extremely attractive from a long-term demand-supply perspective, similar to where office as an asset class was in 2005, i.e., very little institutional quality stock and increasing demand for high-quality offices from multinational companies setting up shop in India. 

Over the last 10-15 years, we have seen that market grow, where about 300-350 million sq ft of stock has been built and traded. Warehousing will follow a similar trajectory; current Grade A stock is only approximately 110 million sq ft with vacancies at 6-8% but is seeing massive demand from large global players in e-commerce and 3PL companies, driving growth. 

To draw a comparison in per capita stock terms, China is about 50x and the US is about 400x of India. To put that into context, most large US cities have more warehousing stock than India's total stock, so clearly there's a lot of headroom to grow over the mid to long term. 

At present, warehouse developers in India are already looking at consolidating their holdings and not selling strata boxes. In the future, this will lead to large institutional holding of warehousing assets over the coming years with the possibility of a future warehousing REIT (real estate investment trust) on the horizon. 

Warehousing is hence poised to come to full terms in record speed. It is today where commercial real estate was 10-15 years ago, but will reach maturity at a greater speed.

With two successful back-to-back office REITs in the recent past, and a couple of more REITs in the pipeline, retail investors are slowly getting acquainted with the concept of REITs in India. 

This is despite the fact that the office market has been largely fragmented with fewer institutional players. Warehousing, on the other hand, has largely been an institution-driven market with $4-5 billion of institutional capital waiting on the sidelines, looking to acquire Grade A assets. 

The expectation, thus, is for REITs in warehousing to develop 2x faster due to multiple factors such as leases are longer and stickier with typical leases ranging from 7-15 years, as opposed to office assets which have shorter tenures. 

These are also high-quality tenants who invest heavily within the warehouse itself, adding further to the stickiness factor and making these assets more stable in the long run. 

Additionally, the rental escalation in warehousing ranges from 4-5% annually as opposed to office assets where there is at best a 12 -15% escalation every 3 years. As a result, in all likelihood, warehousing cap rates will trade finer. Globally, warehousing already trades at a tighter cap rate than office space.

For a possible warehousing REIT in the future, the total Grade A stock will need to rise at a quicker rate leaving a tremendous room for growth. From the global REIT experience, ‘size’ and ‘scale’ are as important as the location and quality of the sponsor or the asset in REITs. 

The quality and quantity of institutional investors from day one in India have been outliers, and almost every organised developer is institutionally backed. 

Over the next few years, a high increase in demand is envisioned and it would be safe to say that the market is looking at a minimum of 3-4 years for warehousing REITs to gain eminence in India. 

The next decade, however, will see this story unfold in interesting ways. The year 2020 will be the year that set it off.

Anshul Singhal is MD at Welspun One.

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