Logistics: e-commerce powering a tailwind in China

China’s commercial property market, and the service industries driving much of the demand to occupy it, afford a valuable perspective on structural changes in China’s broader economy, as the country transitions from its hyper-growth phase to a more sustainable, services-led model.

Logistics, for example, has seen a big buildup in stock in recent years. A World Bank report cites average annual growth of 24 per cent for the period 2006 to 2012. Multiple sources of demand, including the burgeoning retail industry and the manufacturers that sell through it, and auto parts makers serving the world’s largest car market, have attracted a wave of capital to the sector, producing pockets of oversupply in cities such as Tianjin and Chengdu.

Yet the country as a whole is still considerably undersupplied. Even in an age of lower GDP growth, existing drivers of demand – with a strong boost from a newer one, e-commerce – are likely to soak up the oversupply and fuel further growth. In a more competitive market, however, not all space is equal. Larger and more sophisticated facilities are now favoured, and a process of consolidation and upgrading is under way.

LOGISTICS IN TRANSITION

China’s logistics market took its first step into the modern era in 2004, when GLP, the Singapore-based logistics facilities giant and a former division of US-based Prologis, entered the market. Still the largest player, GLP in July announced the establishment of a second China fund, this one totalling US$3.7 billion. But the sector has been shaped by factors unique to China.

Chief among these are China’s land-use dynamics. Local governments have historically been loath to make industrial land available for warehouses because factories and business parks (low-rise offices) generate more tax revenues. This is now changing in some cities. Dalian, for example, is aiming to capitalise on its deepwater port, and looks to logistics as the service sector industry likeliest to balance out its historic reliance on manufacturing.

The national picture, however, shows a proliferation of logistics parks and company-owned warehouses, some with geographical overlap, as well as wide regional variation, much of it owing to local land use patterns.

Thus, in Guangzhou, where land for new logistics supply is scarce, the vacancy rate stood at 0.2 per cent . In Chengdu, where a big new logistics park opened this year and the One Belt, One Road development initiative bodes well for the sector, the vacancy rate was nearly 42 per cent. In Shanghai, home to about half the national logistics capacity, the vacancy rate is under 10 per cent.

Against this backdrop, a powerful new source of demand is gearing up in the form of e-commerce. Online shopping in China has a penetration rate of 10.7 per cent, exceeding the US’s .

Rural consumers who lack easy access to shops are enthusiastically embracing online shopping, almost all of it conducted on smartphones. Alibaba has announced a major push into rural areas and is planning to build 1,000 county-level distribution centres over the next three to five years.

The e-commerce expansion is one of several forces pushing the sector towards larger, more strategically located and more technologically advanced facilities. The growth of value-add manufacturing and the spread of third-party logistics providers are also driving change. But amid land constraints, the key questions will often be where to put new facilities, or where to find existing ones that might be expanded and upgraded to play such a role.

INVESTMENT IMPLICATIONS

Land constraints in prime cities are already pushing development towards nearby cities. Examples are Langfang near Beijing and Foshan near Guangzhou. Similarly, Kunshan in Jiangsu Province, a relatively poor city just across the border from Shanghai, has targeted logistics as a key industry.

In the last five years, just shy of 1.5 million square metres of warehouse space has been completed, and the vacancy rate stands at just 3.7 per cent . We think this is consistent with how the sector needs to develop, but are wary of logistics parks in satellites of secondary cities.

Specialised sectors such as pharmaceutical supply and cold-chain also have great potential, where there is greater value-add. As the middle class grows in size and wealth, and with the central government encouraging investment in private health care, the pharmaceutical niche holds promise. On the consumer side, as people increasingly buy their groceries in supermarkets, and their taste for dairy products grows, so does the need for cold-chain warehouses.

The biggest challenge to investing in the sector may be the sheer weight of capital currently targeting it. Billions have been raised in China logistics funds or committed to local developers by the real estate private equity industry. Because the sector is relatively new and existing stock is in such short supply, much of this capital will likely go toward local developers building out their pipelines, quickly turning land into sheds.

Primary markets like Shanghai will likely have enough demand to keep vacancy rates low. Elsewhere, though, the supply pipeline is likely to limit pricing power for landlords seeking to raise rents – at least until the space is absorbed.

Michael Klibaner is the Head of Asia Pacific Research for BlackRock Real Estate