Industrial and Logistics: positive signals despite downside risks
The latest monthly data and market activity offer positive signals for economic resilience and the stabilising of pricing in the industrial sector, but downside risks to the outlook remain.
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Positive economic data
Inflation fell more than expected in January and the outlook for 2023 has continued to improve in recent weeks, with wholesale energy prices dropping further. Yet, despite the improvement in the headline figures, core inflation remains stubbornly high.
That said, the latest (February) figures raise doubts over whether the MPC will raise rates again in March. Expectations are that any interest rate rise will be 25bps rather than the 50bps movements we have seen recently.
While both Capital Economics and Oxford Economics are currently forecasting a 25bps hike, Oxford Economics expect this end the current programme of quantitative tightening, with rates remaining stable for the rest of 2023, though Capital Economics expect a further rate rise in Q2 2023.
Another signal of economic resilience came from the February UK Manufacturing PMI figures which were also better than expected, indicating a rebound in manufacturing. However, Sterling has strengthened against the US Dollar and the Euro this month, which could impact on export orders over the next few months.
Manufacturers will be watching the Spring Budget closely for support measures, particularly given the recent (Inflation Reduction Act) measures announced in the US. Electric Vehicle start up Arrival recently announced their intention to cut their UK workforce to reduce costs, and to shift their focus to the US in order to take advantage of these benefits.
Sale-and-leasebacks
Sale-and-leasebacks could offer up stock to the investment market. Heightened interest rates are also impacting corporate borrowing rates and start ups that tend to be highly dependent on debt funding are struggling to raise capital due to prohibitively expensive borrowing costs. Those occupiers that wish to raise capital and own their own facilities may look to offer up their facilities through sale-and-leaseback arrangements as an alternative to debt financing.
Well-capitalised corporates taking advantage of current pricing
Negative capital value growth over the past few months has left values (on a £ per sq ft basis) close to where they were around three years ago.
However, rents on the other hand have not recorded any downward movement and continue to rise. At present, prime rents are c.38% higher than they were three years ago, while prime capital values are c.9% higher. Some occupiers are looking to take the opportunity to secure their facilities on a freehold basis and mitigate against rising rents.
Recent transactions in February evidence this trend, for example Global life safety company Hochiki Europe purchased a new 24,000 sq ft facility in Chatham, Kent for £5.5 million and Walkers Crisps has struck a £3.5 million deal to buy land next to its main Leicester factory for a new potato washing facility.
Further signs that pricing is stabilising
According to the MSCI UK Property Index, the Industrial Equivalent yield was 5.91% in January, following a movement of just +6bps m/m. Monthly yield shifts have trended down since October 2022 and the latest shift could be an indication that the period of softening yields has now come to an end.
However, looking at historic patterns of yield shift (across all property types), January tends to feature relatively modest movements and therefore we should not necessarily assume that January will be the last upward movement for yields.
Some further repricing for secondary stock expected
The gap between pricing in prime and secondary markets will increase, with further yield softening likely to be confined to secondary markets.
While prices in prime markets are now showing signs of stabilising, prices for secondary assets/markets are likely to come under further pressure. High build and financing costs are making redevelopment or refurbishment options more costly, while tightening environmental policy requirements are limiting landlords’ options for older assets. From April 1st 2023, it will be an offence to continue to let or rent out a property if it does not have a rating of at least an EPC rating of E.
It has been indicated that these requirements will tighten again soon, with a proposal that commercial properties must have an EPC rating of C or higher by April 1st 2027, and B or better by 2030. This will limit the market for older, inefficient assets and many, particularly those in weaker locations, could face obsolescence.
Buyer and seller price expectations differ
There remains a disparity between buyer and seller pricing expectations. This, coupled with high borrowing costs, is likely to keep investment volumes relatively subdued for the first half of 2023.