by Rupert Nabarro
The fact that this is the year of the industrial property market makes the sector no easier to analyse than it ever was. Warehousing and distribution buildings draw on separate markets to those of manufacturing units. The traditional town-periphery location of industrial estates is being poached both by hi-tech buildings and retail warehouses.
A further difficulty arises because much of the demand for industrial buildings is not for lease buildings at all. Three-quarters of all industrial space is owner-occupied, and owner-occupation is now spreading to the smaller units of newer firms who have traditionally rented space.
The industrial market is, furthermore, a sector of considerable public-sector intervention. Regional policy was pursued through subsidised development of factories. Now a similar approach, in a wider spread of locations, is being pursued for inner-city policy as cheap subsidised space is being promoted in enterprise zones and development corporations.
Difficult as it may be to discover a clear picture of trends in the industrial property market, investors have been in no doubt until recently of the colour of the canvas. From 1981 to 1986 the market has effectively held a no-go status, and no wonder. Total return in these years averaged less than 6% pa, making industrials the worst performing property sector by far. Capital values actually declined each year between 1982 and 1986; rents fell considerably in real terms; and yields increased steadily, pushing up income return on assets from 7.2% to 9.7%.
The industrial market in this period was the victim of two influences. Industrial space is made available in a cyclical manner. Rents fell between 1974 and 1976 as the market struggled to absorb the high level of development of the early 1970s. Revived levels of construction in the late 1970s placed considerable quantities of floorspace on the market in 1980-81 just as the industrial recession bit. The stock of available space was swelled by factory closures and redundancies, while many companies that survived stored up space for the future by moth-balling their existing production areas. It is only recently, in some areas, that this industrial space has been absorbed and any requirement for new buildings has appeared.
The second influence was that of the investment market itself. Industrial property was strongly over-bought in the late 1970s. Funds devoted as much as 25% of their adequate property allocations to the industrial sector — and continued doing so right up until 1981, when the user market was close to collapse. Exaggerated prices were paid for industrial assets which have since proved very difficult to sell. The victims have been concentrated among the property unit trusts and managed funds, which were growing rapidly in this period.
Industrial development from 1981 to 1986 was very limited: indeed new industrial floorspace brought on to the market in 1985 was less than half of that in 1979. Hi-tech buildings were going up in the South East — partly to meet the requirements of the growing electronics sector, partly as surrogate offices. The development agencies were building in the regions. But virtually nothing else was happening.
Has all this changed? Investment committees of the investing funds are certainly being guided towards the industrial sector by their Mayfair advisers. The case goes like this: a lean and healthy manufacturing sector is now growing at 3% to 4% pa; space from the last boom has now been absorbed; building costs in many areas are too high to make new development viable — rents must be bid up to satisfy industry’s needs; special circumstances exist in the regions where the Government is forcing the withdrawal of its own supplier of space (the new towns and regional development agencies) and where markets will find a new balance at rents way above present levels. Yields everywhere are set to fall as the underlying strength of the sector is realised. The diagram on p 60 shows quite rapid manufacturing growth since 1983, decline of available floorspace (King & Co), and real rent levels at a much lower level than 10 years ago.
Although this argument, like so much strategic advice in the property sector, has a ring of credibility, it hides a quite complex underlying situation. Industrial property is certainly doing better. In 1987 it showed a total return of 19.2%. Capital values have stopped falling after five years, and were pulled up last year by a 10.7% growth of rents. Yields have stabilised. Industrial property performed marginally better than retail in 1987 but still remains much the poorest performing sector of the 1980s (8.5% pa against an all property average of 11.4%).
Better performance, however, has not yet been matched by any return of investors to the industrial market. Indeed, institutions have reacted to a more active industrial market by almost doubling their sales: overall they were net dis-investors from the market in 1987. Purchases increased somewhat but to nothing like the same extent as sales, and the 120 funds which contribute to the IPD made no more than 48 industrial purchases between them.
Recent purchasing, too, has been extremely selective — 88% of all industrial investment in 1987 took place in the London and South East region; less than 6% of investment occurred in Scotland, Wales, the North East, North West and Midlands (zero) in toto. Within this pattern more money has been absorbed by standard industrial units (approximately 50%) than in the recent past, and the level of investment in hi-tech buildings, business and research parks has fallen from 60% of all investment in industrials in 1984 to 33% in 1987.
Recent growth of industrial rents is quite variable. It has been much higher for “sheds” and hi-tech buildings than it has for warehouses. Certain regions are seeing rapid growth. East Anglia led the way in 1987 with a 20% growth after five years, when rents had been virtually frozen. Figures of over 12% were recorded for London, the South East and the South West. The movement has, however, yet to spread to the regions: rental values in Scotland in 1987 actually fell, while those in the North and Midlands rose by only between 5% and 6%.
If we take this pattern of growth down to county level, a very interesting picture emerges. The industrial property market is polarised between areas of high growth, high rents and low yields, and areas of low rent and limited growth. Predictably, the development areas of Merseyside, South Yorks and Scotland fall into the latter category; the boom areas of London, Berkshire, Surrey, Cambridge and Sussex in the former. An area of growing rents stretches up the centre of England — Bedfordshire, Northants, Nottingham, Greater Manchester — and it is here that much of the growth of 1988-89 is likely to occur.
Is the current boom sufficiently strong to produce significant levels of development in the regions? Although clearly the market is changing the answer to date is “not yet”. Development proposals for industrial space are running at record levels — planning applications for more than 90m sq ft of new space were received by local authorities between January 1987 and April 1988.
More than 50% of this was, however, in London and the South East and a further 16% in the South West and East Anglia. These areas captured more than three-quarters of all the applications for standard industrial units and some 87% of applications for hi-tech buildings. Industrial development in the regions is still largely limited to larger plant, much of it owner-occupied, and warehousing with its own location dynamics: indeed, the East Midlands and Yorks and Humberside account for around half of all warehousing applications.
At a national level it seems likely that industrial rents will continue buoyant for the next two years. They are at historically low levels and expanding companies are encountering space shortages.
The strong investment demand for industrial properties seems certain to push down yields and encourage further new development. Certain locations and types seem especially favoured — outer London, smaller towns and smaller units everywhere.
The question for the regions concerns how far and fast the upsurge in the economy will spread. The current unholy alliance of high interest rates and a high pound is sure to lead to cutbacks in investment plans. Furthermore, recent manufacturing growth has been strongest in the southern part of the country, partly reflecting a concentration of electrical and electronics industry, partly a spin off from the burgeoning service sector.
Planning in the South East has been greatly liberalised and land availability constraints are hardly what they were. The regions may miss out on the current boom where new development on present showing is likely to be at best spasmodic or patchy.