Changing consumer habits may have reversed the fortunes for physical retail but there has been one big winner. The logistics sector has benefited as retailers move their operations from the shop to the shed. It has been a record 12 months for the industrial sector; investment and take-up volumes have rocketed in response to a variety of additional market drivers. The combined structural pressures of Brexit, Covid-19 and accelerated growth in online spending have contributed to a boom period for sheds.
Unlike its office or retail counterparts, industrial real estate has never been able to forge an identity as a potential spark for cultural or economic regeneration. It has its limitations when it comes to incubating environments in which people want to live, work and play. Instead, its merits lie in its capacity to enable speed, precision and efficiency to the networks it serves. In an era of “levelling up”, “Project Speed” and “build, build, build”, what role does industrial real estate have to play in creating a more productive UK?
The enviable growth in the industrial and logistics sector was not born overnight. It has evolved gradually; multiple forces have been coalescing over a number of years to create conditions for a boom period.
The past 12 months have, however, seen significant forces acting upon those gradual market dynamics of supply and demand. One of those has been the steady recalibration of physical retail. Experts agree there is an over-supply of shops in the country, the consensus landing somewhere between 20% and 40%. In EG’s recent report Retail Disrupted: the pain and the potential we used Radius Data Exchange data to investigate the ramifications of a decade of heady rents, upward-only rent reviews, lofty business rates and the growth that online spend has had on the UK retail estate sector. CVAs, administrations and Covid-19 lockdowns have contributed to almost 40m sq ft of retail space being vacated since 2018.
The past decade has changed our expectations of the shopping experience. In 2010, some 7% of retail spend came through the internet. That figure has since quadrupled, reaching 31% in December. The move has placed enormous pressures on logistics capabilities and supply chains throughout the country. Before the onset of the pandemic, analysis of annual growth by quarter showed online penetration was beginning to slow. The onset and persistence of the pandemic has changed the dial, with online demand expected to settle in the mid-to-upper 20%.
Given the surge in demand from online it is not a surprise that there have been records broken across structural industrial real estate market in recent years.
According to EG’s Radius Data Exchange, capital investment into sheds has been spiking since 2018. The total investment into all industrial and logistics space across all sectors and sizes (and including portfolio transactions) reached £5.8bn in 2020. By counting the entirety of the sheds market, including stock that is less than 50,000 sq ft and sheds considered light industrial spec space, we can map performance in the entire warehousing sector. By this metric, the three-year rolling average for warehouse investment reached an all-time record in 2020, at £6.7bn, up by 7% year-on-year and a whopping 280% up since 2012.
The sustained investment has exerted pressure on yields across the sector, which have hardened by an average of 30 basis points over the past three years. Distribution warehousing investments have proved exceptionally lucrative, moving inwards by 200bps since 2019. This yield compression is expected to persist as investor and occupier appetite for the best in class in industrial stock continues. Falling vacancy rates will inevitably lead increasing rents, further underpinning strong investor sentiment in the sector.
Radius Data Exchange shows a phenomenal year for take-up in 2020, topping 92m sq ft – a 7% year-on-year increase. Amazon has been the dominant driver of take-up, accounting for around 40% of activity, according to figures from Savills.
Savills’ data further shows the effect that Covid-19 – and the populace’s shift to online shopping – has had on the occupier market. Businesses in the parcel (3PL) and online retail sectors have increased their take-up year-on-year by almost 200%. The surge in demand for online food shopping led to a massive 250% year-on-year growth in grocery retail.
Radius Data Exchange data shows that over the past decade the industrial occupier base has been increasingly pivoting away from manufacturing and towards retailing. In 2010, manufacturing made up 28% of take-up in the sector. Today it reflects 20% of activity. Retailing, on the other hand, has grown from 34.9% in 2010 to 52% in 2020.
This strong take-up has pushed average rents up across the UK industrial market over the past decade. The chart above shows that after a period of relative stagnation in the early 2010s (slower take-up and increased over-supply of stock), rental values and lease lengths have trended upward; signalling occupier intent to pay a premium for quality stock, for longer – good news for long-term investors.
All UK regions have experienced rental growth, except the North West, according to Radius Data Exchange. And while the national average UK warehouse rent rose by 1.5% last year to top £7.70 per sq ft, the rate of increase has slowed. Could the market be headed towards saturation?
Using Radius Data Exchange’s availability data we can see how much currently available standing stock (discounting sheds that haven’t been built yet) there is per region, set against the levels of take-up on a calendar year. Six of the 11 UK regions sit above the national average of 1.83 years of stock remaining. The East and West Midlands, along with East of England, remain the most constrained due to successive years of strong occupier demand.
The theory goes that an undersupplied market will see an increase in planning activity to placate that strong occupier demand. National planning for new-build industrial stock has remained at more than 150m sq ft foot annually since 2016 – a sure indicator that there will continue to be a slow and steady release of stock.
It won’t be a surprise that the increasing demand from occupiers for bigger and bigger grade-A premises is being met with developer intent to build out new fit-for-purpose sheds. Indeed, some 88% of all applications for warehouse space since 2014 have been for new premises, while just 5% have been for extensions to existing premises. As the space race intensifies for more grade-A stock in the coming years, some repurposing of existing second-hand grade-B stock may materialise. Change of use, however, has accounted for just 8% of all applications since 2014.
As with the occupier metrics, there are some familiar leaders when it comes to who is lodging planning applications for new space. Property applicants have always made up the lion’s share, but it is the retailers that are slowly becoming the next most dominant company type, rising from a 7% share of planning applications in 2014 to 17% last year. Conversely, industry and manufacturing applications have declined from 14% in 2014 to just 3% last year.
Comparing the absorption rates data with planning activity is one last useful metric when we consider how over or undersupplied a particular sub-sector is. This is a measured approach to finding out if developers are able to respond to an impending supply crunch in different UK geographies. Planning activity is set against a five-year average to give a more accurate benchmark of activity, and therefore a more conclusive answer that stretches beyond the calendar year.
The relative strength of planning over that five-year period means that the figures for 2020 are mostly down on the average. This indicates that while supply is good, the rate at which it is coming through may well be slowing. Indeed, some of those regions which have the lowest absorption rates are at risk from a slowdown in planning activity.
Demand for industrial space is expected to remain robust. Perhaps not as electric as the record-breaking 2020, but rents look set rise and capital investment will remain strong. Overall, supply has managed to match demand for requirements from occupiers, and we have seen record highs for speculative development of new, large grade-A sheds.
As we have seen in the wider real estate eco-system, adaptability to changing consumer habits and technological advancements is defining the future of bricks and mortar. Industrial real estate is and will not be immune from this. Issues will persist around the long-term viability of grade-A stock. With technology moving at such a pace, those that operate in logistics space will require flexible floorplates to meet these changing needs. The solution cannot simply be to keep building more big sheds. Persistent vacancy is already a symptom which effects second-hand grade-B industrial stock and will likely permeate the grade-A market in the coming years.
It is important that while the sector is in a period of growth that precautions are made. Unfettered development will only lead to over-supply and redundant sheds up and down the country.
The industrial sector continues to go from strength to strength, making the most of advantageous conditions, which in recent years have ranged from Brexit trepidation, the rise e-commerce and the short-term effects of consumer behaviour brought about by Covid-19.
Record-breaking levels of take-up, development, investor capital and yield suppression mean logistics space has become the default sector to guard safe, long-term returns. Industrial space remains the invisible yet omnipotent component in the complex real estate ecosystem.
Warehouses are crucial in virtually every supply chain and will remain so for as long as materials and goods need to be stored, handled and moved. The continued expansion in the asset class is expected to fall in line with our consumer habits with a large proportion of its growth coming from our switch to mass online retail purchasing, which has been exacerbated by the events of 2020. Market fundamentals of supply and demand are more also likely to be affected by our changing relationships with our greatest trading partners. These factors have already coalesced to create the conditions for a buoyant market, and as long as they are sustained the sector will continue to grow to fit this growing need.
Click here to read EG’s full report into the industrial and logistics sector for free.
