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Industrial Boom Time

Industrial Boom Time

Once the second cousin of the commercial property world, the industrial sector has come into its own and is now a global darling, finds Miriam Bell.

By: Miriam Bell

1 February 2019

Steady and reliable, but perceived as unexciting, industrial properties have long been considered the second cousin of the commercial property world. But the times they are a-changing and industrial property has started to come into its own.

While the office sector is strong but in adaptation mode, and the retail sector is facing real challenges, the industrial sector has no such problems. It is booming and after years in the shadows, industrial properties are now the darling of the commercial property industry.

So in this month’s sector spotlight, we get the experts’ take on where things are at with the industrial sector, why industrial property is now popular as well as its attractions for investors, and what the outlook for the sector is.

Sector Stalwart

Industrial properties come in all shapes and sizes ranging from small scale “flex” to office warehouse to very large “big box”. They tend to be used for manufacturing, R&D and the storage and distribution of goods. As such they are both necessary and consistent.

Colliers’ director of research Chris Dibble says the industrial sector is often regarded as a defensibly high asset class given its low levels of price volatility and higher returns over the long-term.

“This is a highly attractive feature in an economic cycle which has been running strongly since 2011. Also, 50% of all commercial property sold annually in New Zealand is in the industrial sector. The higher number of prospective purchasers and sellers provides greater depth and liquidity to the market, especially given the often low value entry point compared to other sectors.”

For investors, industrial properties have always been a viable, often more passive investment option.

Veteran commercial investor Jeff Brill says compared to office and retail properties, the yields that an industrial property will provide are typically higher, particularly as regular fit-outs are not required. “Also, light industrial tends to find tenants fairly quickly and the leases tend to be longer. Plus the ratio of income-to-risk in the current market and future outlook is relatively favourable.”

Performance Report

But while the industrial sector always chugged along in the background, it’s now flourishing and gaining widespread attention. The latest reports on the industrial property sector from both Colliers and Bayleys tell similar tales of low vacancy rates and high confidence.

Colliers latest Investor Confidence survey shows industrial investor sentiment remains buoyant across the three main centres of Auckland (59%), Wellington (47%) and Christchurch (32%). Supporting this, their sector report has Auckland’s vacancy rates at record lows (1.7% overall) and Wellington’s vacancy rates also low (2.1% overall).

Dibble says that, in Auckland, warehouse rental growth shows no sign of slowing down at least in the short-term. That’s primarily due to the lack of supply and the sharp reduction in secondary vacancy, which has limited tenant options. “Likewise, Wellington’s market continues to perform strongly, driven by strong tenant demand, a lack of available industrial supply, and growth from local industries.”

Christchurch’s industrial sector is a bit different, Dibble adds. “While rents are steady and yields have firmed, the reduction in building consents suggests the region is slowly returning to more typical market levels.”

‘The yields that an industrial property will provide are typically higher, particularly as regular fit-outs are not required’ JEFF BRILL

Meanwhile, Bayley’s latest industrial report shows that demand for Auckland industrial properties is outpacing new development. As a result, vacancy rates have continued to decline - and are now at historically low levels - while rents have faced further upward pressure.

Bayleys national director of commercial and industrial Ryan Johnson says increasing development activity is hindered by a shortage of land, particularly within established precincts. This is leading to a migration of construction activity to new precincts on Auckland’s periphery.

“Continued demand for a limited supply of industrial investment assets has seen yields holding at historically low levels. But owner sentiment remains positive with further increases in both rental and capital values anticipated by a majority.”

The report also shows that a sharp tightening of Wellington’s industrial property vacancies is expected to drive a new wave of supply over coming years. The economic conditions mean Bayleys expects rents to show further growth over 2018 and values to remain well underpinned.

All the key fundamentals are working in favour of industrial property at the moment, although the shortage of properties, particularly in Auckland, could cause issues down the track.

An additional factor to note is that these days there’s a lot of global money chasing industrial stock, Johnson says. “And that pushes up prices. So where yields would once have been around 8% to 9%, they are now 5% to 6% for a quality property.”

Sector Transformation

That demand is prompted by the phenomenal changes the sector is now going through. Those changes are due to the growth of e-commerce and online retail: they may be challenging for the retail sector, but they are proving to be a bonanza for the industrial sector.

As the likes of Amazon, Alibaba and Ikea grow, the industrial sector is seeing a big uplift in the logistics sector. Industrial properties are increasingly needed for freight forwarding and to cater to the storage and distribution of goods.

Johnson says industrial property has come a long way from sheds and manufacturers. “The space between retail and industrial has blurred. Logistics and supply chain spaces have changed the nature and shape of the sector as we know it. Industrial properties have become both the hub and the spokes of retail and it is taking the sector on a whole new tangent.”

While the full force of the e-commerce boom has not yet hit New Zealand, it is coming, he says. Ikea’s recent announcement that it is looking at moving into New Zealand is just the beginning. “When the retail giants start to move in, it’s going to be great for big sheds.”

An expanding population base also means more opportunities in other facets of the industrial sector like warehousing, manufacturing and construction. Basically, for every new person you need extra space for stock and storage.

But New Zealand, and particularly Auckland, needs more larger-scale distribution spaces. New development is moving out to the more affordable city fringes due to the size required for such builds as well as the costs.

There are still land constraint issues though, again especially in Auckland, Johnson adds. “So another alternative – down the track – might be the type of tall vertical industrial properties they have in high density areas like Hong Kong and Sydney. They are not here yet but we could see them in future.”

Investor Attractions

For investors, industrial property has evolved into an increasingly appealing proposition. For a start, it remains a relatively low cost asset class to invest in. It is possible to buy an industrial property for about $500,000 and get yields of about 5% to 5.5%.

Bayleys national director industrial and logistics Scott Campbell says low vacancy rates, particularly in Auckland where they are below 2%, mean it is not generally difficult to find new tenants. That means there are limited vacancy problems.

“The returns are solid. Tenants pay all the outgoings – insurance, rates, and the like – and they tend to be quite hands-on and look after the property. And when a tenant goes there is not a lot of cap-ex or maintenance that you need to do (unlike with retail or office), so there’s not a lot of fit-out costs involved.”

In many ways, industrial properties are the most simple of the sectors to invest in, he says. “The sector is an easy one to get your head around and it’s also less time-intensive.”

However, when looking to buy an industrial property there are some key things investors need to think about.

Campbell says location is critical. “In Auckland, it’s pretty much wherever you can find somewhere. But, generally, you need to aim for somewhere as close to the city as you can get. Also, it’s good to be close to the main arterials or where they are planned for. And think about the local infrastructure and any future plans there too.”

On top of this, investors need to consider the nature of the building, what the zoning is and, in Auckland, where the Unitary Plan sits, what the body corporate rules are (if applicable), and the fundamentals of any tenant’s business.

‘Industrial properties have become both the hub and the spokes of retail and it is taking the industrial sector on a whole new tangent’ RYAN JOHNSON

Campbell says investors should do thorough due diligence on the property, the building and the tenants, up front. “Do your homework on how the tenant’s business fits into the area and make sure you get bank guarantees and security to make sure you are going to get your income from your tenants.”

For Brill, investors need to be careful of dealing with large multi-national or public company owned industrial tenants as they will negotiate sharp deals on rent. “Rent reviews are the key to capital growth and, with the aforesaid tenants, unless you have a site that large tenants are scrambling over, then you will be buying a dividend and not much else.”

Investors should also be careful not to invest too much in the change of a building to a special use where tenant demand is sparse, he continues. “That’s because if the tenant then goes under or does not renew their lease, you could be up for significant cost to re-modify the building back to where the demand lies. And it could be difficult to re-tenant the building if you don’t.”

Future Expectations

And what does the future hold for this newly energised industrial sector? Looking ahead, the outlook for industrial property sounds pretty good.

Johnson says the sector is now exciting and dynamic and the coming changes to the sector will help with ongoing growth. “We are also seeing continued population growth, land and supply constraints, and building consents that are not meeting the level of demand that they need to be. So more of the same strength lies ahead for industrial.”

Dibble agrees, saying that high demand, low supply, rising rents and firming yields all point to a buoyant market. “We forecast each of the main centres to remain in growth mode over the next 12 to 24 months, but at differing speeds and in different sectors of the market.”

Industrial Investor: David Whiteburn

Prominent Auckland investor David Whitburn owns a 350m2 industrial property in New Lynn, Auckland. He originally bought it via a joint venture syndicate back in 2012 for $1.2 million. There are currently two tenants in the property, one of whom (a mechanic) is a long-termer.

He added a mezzanine floor into the property for about $80,000 a couple of years ago and that brings an extra $15,000 in rent per annum. All up, the net yield for the property is now 8.7% on purchase price plus renovation costs.

“I am happy with this investment. My tenants pay the rent on time and look after everything for me, so I barely see them. I don’t have much to do on the property: it’s just so easy. That’s one of the best things about industrial property. The tenants tend to be good quality plus it’s straight-forward, constant, and hassle-free.”

Whitburn says he’d be interested in another industrial investment. “There are plenty of opportunities with industrial properties. That’s particularly if you get a multi-tenanted property, which cuts down on the risk. And you can generally find ways to add value too. These things are attractive.”

In his view, the outlook for the industrial sector is very strong. There have been steady rent increases for industrial properties of late, he says. “There are relatively low vacancy rates, yields are still pretty good and the market remains under-supplied. I think there’s a lot of confidence in the sector and the market seems pretty strong. It’s certainly not going downwards.”