The sector continues to attract investors and occupiers alike, and the move towards multi-channel retailing and last mile delivery has increased demand for small urban industrial units. This trend is expected to continue for many years, making industrial a highly attractive sector. The changing of the way we live, and shop and how retailers are adapting to consumer demand, together with the current low supply and high demand for industrial provides a compelling investment case.
The opportunity
To gain exposure to the UK industrial sector which offers a diversified and robust income proven to be resilient during economic downturns. Targeting undermanaged estates with relatively low obsolescence where the opportunity for both income and capital growth exists through pro-active asset management.
The sector is underpinned by an increasingly attractive and diverse occupier base which is being fuelled by structural shifts in online retail, technology and higher value engineering and manufacturing. Coupled with this is a continued contraction in supply due to both a lack of development and replacement of stock by alternative higher value uses fulling further the upward pressure on rents. This has already led to significant rental growth (off historically low rental levels) and strong interest from investors to a sector offering a diversified income stream with the ability to perform through cycles.
With supply expected to remain constrained and tenants increasingly requesting longer lease terms, the sector is seeing higher retention rates as vacancy rates decrease at close to one per cent a year since 2010.
The sector has become more institutional in nature and has moved away from noise and waste-creating physical activity to lighter/cleaner storage, distribution and administration, with the emergence of trade counters/wholesalers as the dominant occupier.
Sustained contraction of supply
Supply remains constrained due to the dual effect of limited new development and loss of space to higher value uses such as residential. For example, industrial land in London is being lost at 260 acres per year (1,300 hectares since 2001). Occupier take-up of small and medium sized units (less than 50,000 sq ft) was up again in 2018, leading to fund interest in speculative development and limited delivery of sorely needed new stock. The ability still exists to buy estates at a significant discount to the cost of build or replacement
Strong rental growth prospects
The imbalance in supply versus demand in the sector and the continued loss of space to alternative uses is creating upward pressure on rents, which in real terms remain off a low base when compared to those being achieved in 1992. Industrial remains the cheapest sector in real estate with rental levels having remained historically low in real terms over an extended period.
With the increase in take up and reduction in supply (with little new stock replacement emerging) rental growth in the sector is expected to be close to three to five per cent a year over the next five years.
The rental growth curve also reflects the longer-term affordability compared to 20 years ago and industrial still offers some of the cheapest space available. With rents needing to be materially in excess of £8.50 per sq ft to justify development, limited new stock is emerging and this trend is set to continue with the current low average UK passing rent
An overlooked asset class
The sub sectors of “Urban Logistics” and “Multi-let Industrial” remain an over looked asset class despite having a robust income through diversification of both unit type, size and tenant mix. The pro-active asset management strategies that need to be adopted can put off investors who don’t have the expertise or resources needed. Therefore, the opportunity exists to take an under performing asset which would not appeal to institutional investors and through active asset management and deployment of capex deliver an institutionally acceptable product, with the potential for yield compression. Lot size is relatively low compared to other asset classes (often sub £5 million) and therefore the opportunity also exists to create a yield premium through portfolio accumulation of estates and selling into the institutional market.
There is still value in the sector with pricing for under managed assets remaining at below replacement cost, despite the supply and demand metrics supporting sustained rental growth across the sector. There is no doubt that the case for investing in the industrial sector is strong. Supply is at an historic low while there is rising demand from an increasingly sophisticated and wider tenant base driving rents up. The sector should continue to prove attractive for investors seeking to diversify risk through multiple units and occupiers offering longer-term rental growth prospects due to underlying increase in demand, a reduction in stock and the evolution of online retail.
Barwood Capital is a big advocator of this sector which is already a significant part of the 2017 Property Fund and will continue to be part of Barwood’s future investment strategy.
Hugh Elrington is a Board Director and Head of Property of Barwood Capital, the UK real estate investment manager