The logistics and industrial market remains one to watch in 2018 despite 2017’s fall in take-up
Our latest report shows that take-up for the sector (for units 100,000 sq ft and above) plunged on an annual basis over 2017 as total acquired space topped 24.5m sq ft, down 26.4% on 2016.
However, there are several reasons to think that this is far from a disaster – occupier fundamentals remain strong in terms of supply and demand, and investor appetite for the sector remains unabated.
Demand and its drivers:
So why do we believe that the market is in a healthy state despite a fall of 26.4% in 2017 compared to 2016? The first thing to recognise is that 2016 market activity was unprecedented and skewed by Amazon strengthening its operation. Amazon’s 2.3m sq ft acquisition of five units over 2017 was no match to the 7.8m sq ft it acquired during 2016 as the retail giant moved to the next phase of its expansionary plan. 2016 witnessed a buoyant market activity (circa 33.3m sq ft), which pushed up the five-year annual average take-up level. In 2017, take up came in at just 4.6% below the five-year average.
What are the underlying market drivers that will sustain demand going forward? The structural shift in consumer behaviour and the increased demand for online sales have been key drivers of demand over the two-year period 2015-2016. Similarly, 2017 saw a continuation of this trend with occupiers racing to restructure their operations, albeit at a slower rate than witnessed in 2016. In our opinion, the growth in e-commerce will continue to shape how occupiers and landlords capitalise on the UK’s relentless love for online purchases.
If we take a closer look at 2017’s composition of demand, retailers and third-party logistics providers accounted for a combined 65.9% share of total take-up. This is perhaps unsurprising given that the latest data from the Office for National Statistics (ONS) showed that 16.3% of all UK retail sales were made online during 2017. Moreover, Euromonitor released estimates on e-commerce market share showing, unsurprisingly, that Amazon accounted for 29.7% of total UK online sales.
Some retailers who have struggled to efficiently re-balance their proportion of total sales between physical and online have had to come to terms with sluggish annual sales figures. One example is H&M, the world’s second largest clothing group after Inditex, whose full-year 2017 report stated that the changes in customer behaviour and the consequent drop in footfall had played a significant role in dampening sales volumes. As part of their planned investment programme to increase supply chain efficiency, H&M has recently agreed to take a 750,000 sq ft unit at Magna Park in Milton Keynes.
Looking forward, 2018 will be similar, with retailers continuing their process of restructuring efficiently to compete, while being able to capitalise on the changing nature of customer demand.
What happened to national supply? How are landlords and developers reacting to economic and political uncertainties? Supply for Distribution Warehouses, which also includes speculatively-developed schemes due to come online by April 2018, has edged up slightly to 32.3m sq ft, an increase of 5.2% on 2016 but 15.6% lower than the five-year annual average. This increase was mainly driven by circa 3.1m sq ft of new stock delivered over 2017, albeit a drop of 65.7% on the 9.1m sq ft delivered over 2016.
Despite recent political and economic uncertainty, the UK Logistics sector witnessed more than 12.2m sq ft of space delivered over the period 2016-2017. Nevertheless, this cycle’s speculative development has done little to alter recent supply and demand dynamics. In fact, based on the last five-year average take-up, there is currently only 1.27 years’ worth of supply. Our analysis shows circa 3.74m sq ft of space was under construction as of end January 2018. Among the biggest units to have been completed recently is IDI Gazeley’s Altitude at Magna Park, Milton Keynes, which has delivered 573,845 sq ft of new Grade A stock.
Are investors getting worried about this relative slowdown in demand? Despite occupier activity failing to match 2016’s extraordinary performance, the investment market over 2017 saw circa £10.9bn turnover as investor appetite for Standard Industrial and Distribution Warehouse assets showed no signs of abating. M&A activity helped push investment volumes to a new historical high, up 80% on 2016, with China Investment Corporation’s acquisition of Logicor accounting for circa £2.39bn worth of UK-based assets.
As a result, according to the latest Q4 2017 MSCI release, Total Returns for the Industrial sector hit 19.6% for the year, significantly outperforming the other commercial real estate sectors. Not only that, but on a quarterly basis the Industrial sector picked up momentum over Q4 2017 with 5.9% Total Returns, up from the 4.4% recorded in Q3 2017. Consequently, our Prime yield for Distribution Warehouses, assuming a 15-year unexpired lease term, sharpened by 25bps in 2017 and now stands at 4.75% for un-indexed income.