It’s well documented that the property industry moves in value cycles reflecting the economic conditions of the day. The challenge is predicting the best time to either buy, sell or embrace the new build process. Against this background Martin Mellor, director at Network Space discusses the importance of timing to stay ahead of the curve and the future of the industrial market.
Industrial and logistics property is currently, and is set to remain, a very popular sector of the commercial property industry both for occupiers and investors. “Sheds” were once perceived as the poor relation of the property world, but this has been turned on its head in recent years with industrial property being catapulted to the top of the desirability stakes. Demand for industrial accommodation is at an all time high. Investment and occupational volumes have been soaring and as a result we are now seeing an increasing number of speculative industrial development schemes coming out of the ground.
The fact that historically, industrial property has lagged behind its more glamourous retail and office property siblings is almost certainly down to its modest value growth profile compared to other asset classes. During my career, both offices and retail offerings have seen healthy levels of rental and capital growth which, until recent years have certainly not been attributes that one would have associated with industrial property. For example, over the last 30 years, whilst central Manchester office rents have seen a rise from £7 per square foot to more than £30, industrial rents over the same period have limped up from £4.50 per square foot to their current best levels of £6.50 to £7.50. It’s only in the relatively recent past that we have seen industrial rents exceeding £6 per square foot so, it’s clear to see why industrial property hasn’t always been the “go to” sector for many institutional investors.
As industrial rents have started to move positively in an upwards direction, this has sparked an increase in the level of speculative new build development. It’s marvellous that building sheds has become viable again and to see developers building much needed, good quality industrial stock in locations where the demand is highest. However, it is now becoming more difficult to purchase good quality existing industrial property (whether let or vacant) at a level which would represent a discount to new build costs. In recent years, values have risen to an extent where in many cases some existing stock has changed hands at a premium of 10% - 20% in excess of the cost of building new.
A few years ago, it was simply not good economic sense to build new property, but as rental and capital values have risen, speculative development has very much come back on the scene. At Network Space, we built in excess of two million square feet speculatively between 2000 and 2008, creating quite a substantial investment platform. Interestingly, we have now sold a large proportion of this portfolio (at the same time retaining the property management) in order to both capitalise on the strength of the industrial sector but also fund a substantial current and future speculative industrial development programme.
The truth is, you should never fall in love with your assets to the point where you feel you want to hold on to them forever. Part of the skill behind keeping up with the market is knowing when to sell and when to re-invest in new property thereby driving the best rental and capital returns.
So, what about the future?
The increase in values we are currently enjoying is of course very positive for the industry. But will the growth we’ve experienced in recent years continue for the foreseeable future, or have we reached the top of the market? If there is to be any further substantial growth in capital values within the industrial sector this will need to be led by further rental growth. Indications are that demand for industrial property will continue to be strong and therefore rental values may well move forward. However, naturally values will be tempered by the amount of speculative new build space there is available in the market at any one time. Assuming construction costs remain relatively stable and therefore the supply pipeline is maintained to meet demand, I suspect rental growth will be modest. These dynamics will also contribute to the value of second-hand stock, which naturally (in my view) should not exceed the value of brand-new space.
Finally, in order to build an investment portfolio through development, a good current and future land bank is critical; as is the importance of ensuring that this land is held at a competitive cost. The production process of transforming a piece of land into a completed building can be a drawn-out process and therefore the control of up-front costs and the timing of delivery of the completed product in any evolving market needs very careful judgement. Like in many things in life, timing is critical!