Logistics: as expansion plans ease, the need to improve efficiencies and resilience intensify

Occupier demand over the next few years will be driven by a need for strategic improvements and upgrades to distribution networks and facilities, rather than rapid upscaling of operations. Inflationary pressures are raising the need to upgrade space to gain operational efficiencies. Operators need to improve energy performance and sustainability, and this will result in sustained demand for well located, best-in-class facilities.

Despite slowing growth in the e-commerce sector coupled with rising costs and economic uncertainty, the strength of the occupier market continues with a diverse mix of operators seeking space, driving record levels of investment and rising development activity. Vacancy rates and availability of space are at an all-time low.

This lack of existing stock, coupled with strong rental growth is prompting an increase in development activity and we expect a robust uptick in development completions over the next six months.

Rising land and construction costs

While rising land values and build costs offer support to capital values, the rise in development activity may contribute to a slowing pace of rental growth over the next few years, particularly in the big box market. That said, construction activity remains measured, and vacancy rates are at record lows.

Rising uncertainty around construction materials pricing, along with the prospect of further interest rate hikes which will drive up the cost of financing a development, are likely to curtail speculative development activity. Rising construction costs for warehouses mean investor/developers will face tighter profit margins and thus their appetite to develop space speculatively and take on additional risk of a void period will decline over the coming months and some speculative schemes scheduled to start later this year may be put on pause until a tenant is secured. This will keep supply relatively tight.

Online retail growth

The pandemic accelerated the growth of online retail and drove retailers and distribution firms to acquire space and rapidly expand their footprint in order to capture a share of the growing market. E-commerce will continue to be a key driver of occupier demand for warehousing space and many firms have committed to space that is not yet built, demonstrating their plans for further growth over the longer term. The “race for space” we have witnessed for warehousing over the past couple of years will ease as the e-commerce market matures, though the sector remains in expansionary mode.

Prime and secondary yields

The gap between prime and secondary yields has narrowed over the past two years. Though secondary locations have not witnessed the same level of rental growth, hardening inflationary pressures are likely to have a particularly adverse impact on the SME’s that dominate the tenant mix at secondary industrial estates.

The rising prices of commodities, consumer goods, transportation and energy are impacting manufacturers, logistics operators as well as consumer demand and the rise in business rates in April 2023 will add to these pressures. Given the narrowing gap between industrial property and gilt yields, assessing the risks associated with a weaker covenant and location will become increasingly important for investors.

Increasing environmental standards and energy costs, coupled with higher redevelopment/retrofitting costs and a rising supply of new facilities, does pose a risk of stranding some secondary assets that have fallen behind in terms of environmental/energy performance.

Read more or get in contact: Claire Williams, Industrial and Logistics 

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