Industrial Property Snapshot
Much has been made in recent years of the "death of the high street", so much so that we're probably getting a bit bored hearing about it.
Whatever your views on that subject, what is becoming increasingly clear is that the structural changes in retail habits are creating opportunities elsewhere in the property market. Investor appetite for good covenants in the retail and leisure market is strong at present, but it's worth taking a moment to look at the gathering momentum in the industrial sector.
Lambert Smith Hampton's recent update for the Second Quarter of 2017 on Distribution Warehouses reports that rolling average transaction yields for industrial property was lower in Q2 than for retail for the first time ever (5.8% vs 6.09%). Knight Frank's Logistics & Industrial commentary for H1 flags capital growth at an annual rate of 6.2%, with annual rental growth of 3.8% in June 2017, well ahead of inflation; so we are seeing both yield compression and rental growth that is well ahead of inflation -- all that against a backdrop of Brexit that has seen occupier take up down by 15% on the previous 6 months.
The driver behind this is clear -- overall growth in demand for distribution centres to accommodate the rapid increase in on-line shopping, coupled with a real shortage of new development. The demand is not just at the larger end of the scale, however -- as consumers have become more demanding, on-line retailers have been pushed to meet ever more challenging delivery requirements causing pressure on retailers to create both regional distribution hubs as well as an effective network of smaller centres to fulfil "last mile" delivery to consumers' front doors.
The last few years has seen a number of REITs come to the market who specialise in industrial - Tritax Big Box REIT and Pacific & Industrial Logistics REIT spring to mind. But these are largely viewed as investors, not developers. It is telling that the most active developer of new industrial space in Central Scotland recently has been Fusion Assets, a development vehicle run by North Lanarkshire Council. Despite rental growth and yield compression over the last 12 months, the speculative construction of new industrial space by the private sector often does not stack up. If trends continue on their current path, however, then we may soon see a tipping point.
If we are serious about encouraging a UK manufacturing renaissance post-Brexit, then it is self evident that businesses need premises that are fit for purpose from which to operate. The growth of on-line retailing has created significant competition for space and it will be important to foster an environment where the development of new industrial space by the private sector is financially viable. That does not just mean an increase in industrial rents.
The cutting of void rates relief for Scottish industrial property in April 2016 undoubtedly had a negative effect on the sector. Tales of landlords choosing to demolish secondary space rather than invest in refurbishing it in the hope of securing a tenant were more than just apocryphal. There are some positive signs ahead, however. The Scottish Government has indicated its willingness to adopt the majority of the recommendations that came out of the Barclay Review into business rates. More frequent revaluations and enhanced relief that will see new build properties not pay business rates until they are occupied for the first time are welcome and will help to encourage more development to meet demand. Led by the good work being undertaken by Fusion Assets, there is also a role to play by local government to partner with the private sector and lead the way to invest in the creation of a new generation of fit for purpose industrial stock to support manufacturing growth and meet the demands of a retail sector that is going through immense structural changes.
There is no sign of investor appetite cooling in the near term and it would not take much (for example, a softer deal on Brexit) to unblock investment decisions and further stoke occupier demand. In that context, the investment sector is one that I'll be keeping an interested eye on over the next 12 months.
*This 15% figure strips out the effect of a single 2.2m sq ft letting to Amazon in east London in the last 6 months of 2016.