Short-term oversupply in some cities, but strong long-term growth fundamentals

The landscape for the logistics sector has shifted after several years of solid expansion. Single-digit economic growth, slowing manufacturing investment and caution within the retail market, combined with increasing cost pressures and selective oversupply, has created new dynamics in demand and competition. Alpha cities are facing competition from nearby satellites and some Tier 1.5 cities are seeing elevated vacancy amid the rapid growth in supply.

Nonetheless, the sector's long-term growth mechanisms remain exceptionally strong, underpinned by an expanding domestic market, growth in organised retailing and the mushrooming of e-commerce. The huge investment in China's highway network has improved connectivity and is enabling businesses to consolidate distribution networks into fewer yet larger and more modern facilities.

The boost from e-commerce and omni-channel retailing

While the expansion of China's physical retail market and its huge manufacturing base have remained the main drivers of demand for modern logistics facilities, e-commerce and multi-channel retailing have emerged as new engines of growth. Strong demand from e-commerce companies, such as Alibaba, JD.com and Yihaodian, as well as third-party logistics operators (3PLs), is taking up the slack from the slowdown in demand from other sectors of the economy.

Logistics sector is consolidating

Slimmer margins and rising competitive pressures are driving 3PLs to consolidate their logistics space, seeking economies of scale and rationalising multiple facilities into fewer, larger multipurpose units that serve a range of functions from handling imports to e-commerce and retail distribution.

Consolidation is expected to intensify among e-commerce companies as the market expands. The winners will be those that can achieve scale and operational efficiency, and this will boost the demand for modern facilities.

Growing government recognition of the value of logistics

Land supply has traditionally constrained the development of logistics across the China60 cities, but local governments are now adopting a more positive attitude towards logistics. While there remains a strong preference among governments for higher-value manufacturing, the decline in manufacturing investment has encouraged them to provision more land for logistics, particularly where relocation helps free up land in inner city areas or economic zones for expansion of higher-value uses.

Still an under-provision of high-quality warehousing stock

With the logistics stock increasing at annualised rates of 15%-20%, short-term oversupply issues have emerged in a few cities – such as Tianjin and Chengdu – but these expanding cities are in the process of building out their logistics infrastructure in response to strong demand for regional distribution facilities. Over the medium term, this space will be absorbed.

At only 29 million square metres, Grade A stock remains small given the scale of China's economy, and there will continue to be capacity constraints on the amount of new space that can actually be constructed. The current Grade A non-owner-occupied stock is miniscule in comparison to the combined equivalent stock of major markets in the United States, which is close to 155 million square metres.

Supply chain networks are becoming more complex

Logistics networks are becoming ever more complex in China's densely-populated mega city-regions of the Yangtze River Delta (YRD), Pearl River Delta (PRD) and Bohai Bay, where two-thirds of China's modern logistics space is located.

West, Central and Northeast China are witnessing the fastest growth in logistics space as supply chains develop in response to the continued shift in manufacturing activity to Central and West China, and also to the growth of inland and lower-tier retail markets - both of which have been supported by the huge investment in highway infrastructure.

China's distribution networks … the next stage?

As China's logistics industry evolves, there is no 'one size fits all' model standing by for it to follow. A mosaic of logistics networks will develop in response to the different and unique demands from retail store distribution, domestic and cross-border e-commerce, manufacturing supply chains and the import/export trade.

Specialist distribution hubs will thrive in densely-populated areas with superior intra-regional connectivity; and over the longer term, China's expanding network of national highways will facilitate the development of truly pan-China distribution networks (along the lines of those in the United States), although this trend is still some way off.

E-commerce will be a game-changer. China currently lags behind most developed economies in terms of its e-commerce 'ecosystems', but the gap is closing rapidly, which will lead to a wave of new demand for mega e-fulfilment centres, parcel delivery/sorting centres, returns processing centres and urban logistics depots. In this respect, the sector will be in uncharted territory.

The logistics sector in China still faces many hurdles in terms of industry fragmentation, vast regulatory differences between administrations and, crucially, a lack of skilled supply chain manpower, which will slow the pace of automation.