CEE Legal Matters has been reporting on an increased number of deals in the Czech Republic’s logistics sector. We reached out to several Czech real estate lawyers to discuss both the drivers behind the spike in work in the sector and the challenges it faces in the country.
Geography, Timing, and Investors
“We witnessed a strong reawakening of the industrial and logistics real estate sector at the end of 2020,” comments Allen & Overy Partner Prokop Verner, adding: “we see a sharp rise in industrial and logistics property investments indicating that the upward trend continues throughout 2021.”
BPV Braun Partners Partner Jiri Barta attributes the high level of activity in the country’s logistics sector to its strategic position. “The Czech Republic and the whole region profits from the geographic location in the center of Europe. Slowly but surely the system of highways has been improved not only in the Czech Republic but in Poland and Slovakia, too,” he says. “That makes the whole logistics sector work faster and more effectively.”
While geography might have helped, PRK Partners Partner Roman Pecenka points to the COVID-19 outbreak as the main driver for the sector as it led to an “unprecedented expansion of e-commerce.” Barta echoes him: “obviously with the whole COVID-19 situation, when many shopping malls were closed due to the lockdown and on-line shops and home deliveries increased massively,” it was logical that logistics went on a rise.
“Other long-term drivers, such as the effort to move goods in the supply chain closer to the customer (thereby improving client service) and the effort to reduce dependency on the Chinese market, have also pushed the growth of the industrial and logistics real estate sector,” adds Verner.
And investors see the promise that the sector holds. Kinstellar Partner Klara Stepankova explains that “in the Czech Republic, the sector is not only driven by the increased demand from occupiers prompted by the further penetration of e-commerce but also by the increased interest in this sector from institutional investors.” She adds that their office has “been working for many experienced players in the sector on the development and investment side for years, but recently we have seen a lot of newcomers to logistics. These are typically investors who previously focused their attention on traditional asset classes, such as offices and retail, and moved their investment strategy to logistics not only because of the current lack of available suitable products but more importantly because of uncertainty surrounding the future of offices and retail assets.”
It’s not just the pull factor of the logistics sector but also the push factor of other potential investment targets, with Emil Holub, Partner and Head of Real Estate with Clifford Chance Prague, believing that this interest from investors is also due to a gap in investing in other sectors. “The logistics sector has become very dynamic mainly due to the lack of other investment opportunities in other sectors – retail was complicated even before 2020 and with the COVID-19 impact the retail sector is on a break,” he says. “The office sector is impacted by Covid-related uncertainty and also by the lack of quality products (i.e. the office offering) in Prague, which makes up the vast majority of the office investment market.” He also feels that the hospitality market is not yet in the distress “which was anticipated after COVID-19 and that other alternative assets (such as student or elderly housing, data centers) are not yet really developed in the Czech Republic.” As a result, Jakub Adam, Partner at Taylor Wessing, sees investing in logistics as logical and predictable. “Unlike other sectors, logistics has not been negatively impacted by the Covid-related restrictions. It is generally considered a safe investment, banks consider it safe harbor,” he says. “Besides banks, logistic developments also have multiple other sources of funding, including IPOs and bonds.”
Show Me the Money
When it comes to the sources of investment, Pecenka says that “the most important recent deals were driven by established foreign funds, which confirms their continuing interest in investments in Czech assets.” Holub adds that “around half of the investments come from sovereign funds originating in Singapore, the Gulf, China, and Norway. And the remaining investments are coming from all over the world – the UK, the US, or Australia.”
And strategic investors play a big part as well with Barta saying that the automotive sector is still a dominant driver, followed by light industrial production, and that “we must not forget about the retail sector, the players keep expanding and improving their regional hubs.” Glatzova & Co Partner Erik Kolan points to a “high demand for car parts and machinery, and an associated demand for logistics facilities.” He adds that the transition to electro-mobility also increased the demand for new facilities (with existing contracts for supply with Skoda and Volkswagen) tailored for e-car manufacturing. According to Kolan: “The car industry is big in the Czech Republic. Although it was hit hard by COVID-19, as it usually is in any crisis, it is recovering and is a driving force for the logistics sector.” Echoing Barta’s second point, Kolan talks about “a giant logistics center for Tchibo, which they’ve already enlarged twice, in the town of Cheb, in Bohemia, very close to the German border,” as well as an Amazon distribution center near the Prague Airport – both servicing the whole region, not just the Czech market.
Ultimately, when it comes to investment sources, Holub notes that they vary a lot. “Some of the investments are financed domestically, some by bonds and equity issued on stock exchanges,” he explains, with Adam adding that “some developers opted for an IPO (as CTP did recently), some generate funds from bond solutions (such as Accolade), and some developments are debt-funded (as banks generally consider logistics projects a safe investment).”
Room to Grow if You Have Strong Nerves
“The market is far from being saturated, the very low vacancy levels for logistics parks and the increasing rents are a good testimony to that,” Stepankova says. “One of the logistics sector’s segments that we see as having potential for further growth is last-mile logistics projects. As retail will have to completely reinvent itself into new ways of functioning, there might be opportunities for the conversion of parts of certain retail schemes into other uses, including logistics. There is definitely room for new projects,” she concludes. Holub adds: “Judging from the plans of our clients in this sector, each of them has an appetite to grow and build new logistics centers. There are also new concepts such as ‘last-mile’ or ‘flexi spaces.’ Lastly, looking at Western Europe where new trends usually appear earlier than in the Czech Republic, we may also see the conversion of badly performing shopping centers, especially at the outskirts of large cities, into logistics centers.”
Verner notes that “demand in the sector has long outstripped supply and, as long as this remains the case, there will still be room for new projects,” but that a simple hunger for more space might not be enough. “The developers are eager in expansion but there are so many obstacles that the entire process requires strong nerves and a lot of patience,” Pecenka notes. There are several factors at play here.
First, “over the years the logistics assets have become very consolidated and are held by a relatively small number of real estate players,” Holub says. “Moreover, most of these players in the logistics sector are ultimately held by sovereign funds who are not ready to sell and are prepared to hold these assets for a long time.” He adds that the other dominant developers “generally do not sell to the outside market and keep the assets for themselves. This makes the remaining logistics assets developed by small independent developers very desirable and the resulting pricing is exceptionally high.”
Second, Pecenka says that “even good locations are facing increasing resistance from local municipalities and inhabitants. Due to the Czech tax system, they do not have many positives from this kind of investments but have to face all the negatives.” Kolan explains: “Ten or fifteen years ago if you were a logistics investor going to a municipality, they would welcome you. But now, because the unemployment rate is very low, they have less of an incentive to welcome a logistics center and the perceived disruption associated with it, like heavy traffic and an influx of foreign workers. So from a political standpoint, local authorities and voters are shifting against these facilities, as they no longer need new jobs for the locals and do not want to deal with the potential disruption.” He mentions an instance in Northern Bohemia, the region with the weakest economy: “In an area designated for logistics development an investor bought land and invested a lot of money, fully in line with the zoning plan. Yet the relevant municipality as well as a neighboring one are trying to change the zoning and impose construction bans. For a year now we’ve been fighting them to respect the existing zoning project and permits.”
As a result, Pecenka describes the logistics sector in the Czech Republic as “a total landlord’s market. And it is unlikely this will change anytime soon, due to steadily increasing prices of land, of construction works & materials, and the disastrous length of permitting process.”
Is the Czech Government Helping?
“I don’t think the growth in this sector is really government-driven,” says Kolan, with Adam too stating that “the impact of government activity on logistics’ growth is neglectable if any at all.”
While Verner notes that the Czech Government did provide minimal support to the sector through the Smart Parks for the Future program, he says “it is obvious that private capital is and will remain the primary driver in the logistics sector.” Holub echoes this by saying: “From experience, the less governments interfere with business, the better. On the other hand, we see that councils of the Czech regions and mainly municipalities have been actively building barriers to future logistics developments, with strong support from local communities, as those communities do not favor logistics centers near to their homes.”
Holub adds that “permitting of new projects has thus become even more complicated,” with Adam noting that a “critical issue is the length of permitting procedures, which the Government is attempting to tackle by way of the new Construction Act. But the outcome is uncertain and will only be recognizable mid-term.” Kolan is not too optimistic on the act’s timeline: “There is a wish to shorten the permitting timespan. A central building authority will be set up, taking that responsibility away from local municipalities. The hope is it will help to professionalize and speed up the process, reducing the number of binding opinions that need to be obtained from different authorities. So, there is a chance the new code will help. But it will only start running in 2023 and the process will take time. It will probably take several more years before things settle down and become easier.” Pecenka is not holding his breath either, saying he does “not believe it might have an imminent positive impact on the permitting process. It is more likely it will create additional burdens and uncertainties.” The feeling is echoed, on a slightly more optimistic note, by Verner: “Due to the complex remodeling of the public administration structure anticipated by the new Construction Act, we expect that it may initially cause a certain disruption in the permitting procedures. However, in the long run, we trust that the new act will meet its goals and will serve to accelerate and simplify real estate development in the Czech Republic.”
Ultimately, “if you were building a factory for lithium batteries, the Government would step in and help you,” Kolan says. “But they see pure logistics projects as adding less value, and the classical incentives available since the 90s are more or less gone. They are now focusing on research centers, e-mobility, and other projects with high added value.”
Despite several challenges faced in the market, most are optimistic about the sector’s future, even if certain drivers will change. Pecenka says he expects the uptick in logistical work to continue. And so does Verner: “I expect that the established trend of growth in the industrial and logistics real estate sector will continue further, even after the pandemic. The pandemic has, among other changes, accelerated the development of some industrial sectors and shifted the focus of customers to e-commerce. I believe these new consumer preferences will last and continue to benefit the industrial and logistics real estate sector in the long run.” Kolan agrees as well: “all the main drivers for the logistics sector will continue – it’s inevitable.”
“Though the pandemic’s end may bring customers back to the shopping centers and employees back to offices, it will never be the same as before – new habits were established and the world will not be the same again,” Holub adds. “I expect that there will be an even higher demand for last-mile logistics and also that some of the production done elsewhere will be moving closer to the customers.”