Large industrial (50,000 sq ft plus) take-up during Q2 2014 dipped by 19% on the previous quarter, but increasing development activity is beginning to address the market’s supply issues, according to Gerald Eve’s latest Prime Logistics bulletin.
Total take-up stood at 8.4 million sq ft, compared to 9.8 million sq ft in Q1, a figure that is just below the five-year quarterly average, but above-trend on a rolling four-quarter average. The largest individual deal of the quarter – indeed, one of the largest of the past ten years – was Primark taking 1.06 million sq ft at Islip in the Southern East Midlands, a letting that not only underpinned Q2’s take-up, but also demonstrates the continuing demand in the market, albeit from a retailer with no plans to sell online.

Expansionary activity has been key to demand so far this year, and with companies such as JCB, Asda and MySale all intending to implement expansion plans, this is expected to continue in the short- to-medium-term. In particular it is in the online retail sector, following on from The Hut Group’s acquisition of nearly 800,000 sq ft across two buildings in Warrington in Q2 that will be one of the main drivers of expansionary demand.
Supply & development

There continues to be a lack of space, particularly high-quality stock, and the overall availability rate during the quarter ticked down to 9.7%, the lowest ever recorded by Prime Logistics. In turn, development activity has been increasing steadily for the past year and will soon begin to address the market’s supply issues; as such, availability has arguably reached its nadir for this property cycle and there will be gradual increases over the medium-term.

With 13 million sq ft under construction due to be delivered this year or next, development is at its highest level since Q2 2008, with speculative also increasing, to just less than 2.5 million sq ft currently under construction. A total of 4.7 million sq ft of space started on site during Q2 – the largest since the end of 2007 – of which 1.8 million sq ft was speculative and 30% was in the London East region. It should be said, however, that speculative development is still a long way short of the totals under construction during 2007.

Steve Sharman of Gerald Eve’s research team said: “Although take-up dropped in Q2, on a rolling annual basis, demand is above long term averages. We expect take-up to improve further in the second half of the year, with continued expansionary demand from major occupiers, especially in the retail and internet retail sectors, and we can look to the development market to see the optimism that is prevailing at the moment.

“New peaks of development, both pre-let and speculative, are a function of both occupier demand and constrained availability, and we expect both factors to continue into the medium-term. We have not as yet seen occupational demand significantly outperform long-run averages though, and continue to wait for the positive impact of a resurgent economy to be converted into significantly increased volumes of take-up.

Richard Ludlow, Head of Gerald Eve’s Logistics Team said: “Availability is at very low levels, and development activity will slowly add to supply volumes over the next few years, but as things stand the lack of suitably high-quality space, crucially in the right regions, remains a significant constraint on the market. Current development activity will eventually increase occupier choice, but demand continues to outstrip supply and this does not dampen our view of continued positive rental growth.”

The amount of capital targeting the investment market continued to increase during Q2, with capital-raisings and new fund creations contributing to the seemingly ever-growing wall of money. With low levels of supply, development still weak by historic standards and occupational demand strong and growing, it is perhaps not difficult to understand the attraction of the sector.

Prime yields continue to compress on best-in-class stock, as evidenced by L&G’s £114m forward-funding of Waitrose’s Magna Park warehouse; which at a net initial yield of 4.64% set a record low yield for the current cycle. The increased capital targeting the sector is being channelled into a limited amount of prime stock and yield compression at the top of the market is by and large being driven by one or two of the more aggressive bidders.

Given these conditions, new money allocated to the sector is likely to be aimed towards development activity and higher-yielding assets. IPD is already reporting superior quarterly total returns for higher-yielding assets compared to lower-yielding – the first time this has happened since Q2 2010 – and we expect this trend to continue.

George Underwood, Investment Partner at Gerald Eve, adds: “The weight of money for prime logistics stock increased further during Q2 and continues to significantly outstrip supply. This ongoing supply / demand imbalance is resulting in new benchmarks being set quarter-on-quarter and inevitably the heat at the top of the market is pushing greater numbers of investors to consider alternatives such as secondary and development opportunities.

“As such, we are already witnessing prime-secondary yield convergence and prime land values are quickly returning to their pre-recession levels.”

Richard Ludlow continues: “So far, the speculative development activity in the market has been largely undertaken by self-financed companies and has been very targeted and selective in terms of location. As more capital is channelled into the development market, we will see more speculative schemes and perhaps more people considering development in less core locations given the very constrained land market.

“Notwithstanding this, rising land values and increasing build costs are rapidly off-setting the recent inward yield movement and therefore sustained rental growth is likely to be needed to justify more widespread speculative development.”

First produced in 2006 (analysing the 2005 market), Gerald Eve’s Prime Logistics bulletin focuses solely on industrial warehouse properties of 50,000 sq ft or more in size.