Industrial and Logistics Market
The UK industrial and logistics occupier market recorded a solid if unspectacular level of take-up during the first half of the year. Across all size-bands, take-up in H1 2017 was 43.9m sq ft, down 7% on the same period last year and down 6% on the half-year average.
H1’s volume of activity is arguably respectable given the ongoing uncertainty over the UK’s future relationship with the EU and the fact that growth in the UK economy has slowed since the beginning of the year.
However, take-up was boosted by a number of very large deals. H1 saw two major development purchases, namely Neovia Logistics in Desford, East Midlands (1.2m sq ft) and Amazon at Avonmouth near Bristol (1.2m sq ft).
These, along with a number of other major deals, skewed take-up larger end of the market. Logistics take-up (>100k sq ft) was up 4% on the same period last year and 6% above the half-year average, although take-up of 500k sq ft plus units was key to this, with take-up here more than 50% above the half-year average.
The majority of UK regions saw overall take-up below their respective half-year average. Regions which recorded take-up above trend were largely dictated by large deals. This was especially true of the South West, where deals by Amazon and Honda skewed overall take-up. This was also true for the East Midlands, where deals to Neovia Logistics in Desford and Gardman in Daventry (413,800 sq ft) boosted volume. Conversely, take-up in the North East and East regions both fell short of their average reflecting subdued activity in the larger end of the market.
However, a number of UK regions revealed a healthier pattern of activity if the larger end of the market is overlooked. For example, the North East and East regions both recorded above average activity in the small to medium size-bracket (units >50k sq ft) despite below par take-up overall. Conversely, take-up in the South West was below par in the smaller and mid-box size categories, despite being the UK’s strongest performer against trend for overall take-up.
First supply increase in eight years
Overall supply edged up for the first time since 2009. UK-wide availability increased by 3% during the first half of the year to stand at 166.0m sq ft. Despite the rise, supply still remains considerably below the long-term average.
While a number of second-hand buildings returned to the market during H1 2017, the increase was largely driven by speculative development. Grade A stock increased by 25% during the first half of the year, largely reflecting new development completions. Notable examples included Graftongate’s M6DC, Cannock (372,000 sq ft) and Prologis’s DC9, Marston Gate, Milton Keynes (278,331 sq ft).
While the quantum of speculative development has eased down at the larger end of the market over the last 18 months, the focus has shifted to the smaller end. The volume of <50k sq ft units under construction increased over 30% since the beginning of the year, with activity focused in the South East.
In contrast with other core property sectors, meaningful rental rental has been a familiar pattern across all UK regions over the past few years. However, while industrial rental growth has run far ahead of the other sectors post Referendum, it has eased down during H1 2017.
For the 60 key UK markets, average rental growth for prime stock was 1.2% during H1 2017, a discernable change in pace compared with the 3.6% growth in H2 2016. Similarly, rental growth for secondary stock has also slowed, easing down from 3.5% in H2 2016 to 1.8% in H1 2017.
While secondary rental growth has consisently outperformed prime over the past four years, the gap between these growth rates has become marginal over the past 18 months. The narrowing of the gap is likely to reflect increased level of choice in the market for grade A space, spurred by a revival of speculative development.
Regionally, Scotland was the standout performer during H1. Its key markets recorded average prime rental growth of 6.0% over the period, followed by the North East with growth of 2.3%. This pattern reflects the gradual rippling out of growth from London and the South East since the start of the market cycle.
Industrial and Logistics Market
Explore take-up, availability, rents, prime land values and key deals across the UK.
While the relative performance of the Industrial & Logistics sector goes from strength to strength, the main challenge is finding value and opportunity in the market.
Industrial volume bucks the trend
Strong demand for industrial and logistics assets has been clearly reflected in transaction volume. £3.7bn of assets changed hands in H1 2017, the second highest level for a half-year period on record. This stands in marked contrast with other property sectors, where H1 volume for regional offices and retail undershot their trend level.
Activity also gathered pace as H1 unfolded as more sellers opted to bring to stock to the market. Q2 volume of £1.9bn was the highest since Q4 2014, driven by a record quarter for distribution warehouses, with volume of £1.3bn.
Many key deals were done off market in Q2, including Tritax Big Box REIT’s acquisition of Ocado’s warehouse, Birch Coppice (NIY 5.25%) and a Korean Consortium’s purchase of Sainsbury’s distribution warehouse, Hams Hall (NIY 4.77%).
A crowded marketplace
Having traditionally been dominated by the institutions, the market has become significantly more crowded and competitive. While strong investor interest exists for secure income stock as elsewhere, constrained supply and positive occupier market fundamentals in the sector are also driving strong demand for short income and asset management opportunities.
H1 2017 saw virtual parity of volume between domestic institutions and overseas buyers, both of whom invested circa £930m during the period. Competition has been fierce for openly-marketed stock, with strong interest from institutions, quoted propcos, overseas and private investors. A number of multi-let estates sold in Q2 saw over 10 formal bids, with up to four rounds of bidding in some cases.
2016 saw the emphatic arrival of local authority buyers to the market, at trend which has continued in 2017. Taking advantage of access to low borrowing costs, local authorities purchased £160m of industrial assets in H1 2017 following purchases of £224m in 2016. Their advantageous position has been quite disruptive for well-let sub-£20m lot-sizes, where interest is primarily focused.
Yields pushed to record lows
Following a brief wobble either side of the Referendum, yields across all types of industrial & logistics assets were back under pressure in late 2016, fuelled by a combination of limited stock and attractive occupier market fundamentals.
On the back of very strong demand, prime yields for South East estates have moved below their pre-Referendum level to a record low of c. 4.50%, while prime multi-let product elsewhere is the UK is capable of achieving 5.25%. Similarly, after a period of relative stability, prime single-let distribution yields also hardened by 25bps during H1 2017.
However, yields for secondary industrial product have compressed much more considerably as investors have moved up the risk curve in search of stock and better value. This was reflected in average transaction yields in Q2, where - for the first time ever - the rolling annual average transaction yield for industrial (5.9%) stood lower than retail (6.1%).
Industrial and logistics is firmly on course outperform the wider market once again in 2017. Benefiting from both rental growth and ongoing weight of money targeting the sector, total returns are forecast to outperform All Property in both 2017 and over the five-year horizon.
The search for value
At this stage of the cycle, the main challenge for would-be industrial investors is securing stock, particularly as there is little incentive for sellers to move out of a lead performing sector.
The obvious outlet for investment is through selective refurbishment of existing stock or speculative development. Given structural change in shopping patterns, one particular strategy is to target existing assets in or around densely urban areas and refurbish product for the burgeoning need for ‘last-mile’ delivery centres.
While the case for new development is compelling given prevailing dynamics in the occupier markets, investors are understandably more cautious in light of the more uncertain economic outlook. However, those brave enough to see through this risk and have faith in the long term structural growth of ecommerce may enjoy the greatest upside.