_Industrial speculative development momentum maintained despite economic downturn

The fallout from the COVID-19 pandemic’s restrictions on movement has further accelerated the established trend of online purchasing activity and the associated need for streamlined and cost-effective distribution systems. This has seen the demand for new prime industrial space remain high, and as a result we continue to see sustained appetite for speculative development, as evidenced by the latest data from Brisbane.

Jennelle Wilson June 29, 2020

Search for greater supply-chain and delivery efficiency

The enforced break from non-essential physical shopping, and for many, a break by choice from supermarkets, saw a sudden increase in online spending as social distancing measures impacted the population. While the take-up of on-line retailing in Australia has been steadily growing over the past five years this sudden change in behaviour is considered to have accelerated the penetration of online purchasing by a factor of 3 years according to Ben Franzi, General Manager of Parcels and Express Services for Australia Post. Now estimating e-commerce penetration of almost 16% (up from 11.5% in three weeks), Australia Post described the surge during March and April as “Christmas Like”, with volumes in April 2020 reported at 6.8% higher than the busiest period in 2019, requiring the company to take overflow space in 15 locations across Australia.

The current economic situation and expected constrained economic growth for the near future means retail margins are likely to be reduced in a discounting environment, placing greater pressure on supply-chain efficiency to maintain or grow profitability. This will continue to flow through the entire manufacture, transport, wholesale and retail ecosystems as consumers demand more goods, better tracking, faster delivery and “on-sale” prices as the norm. Central to industrial tenants’ property upgrades is the search for efficiency and cost minimisation while embracing multi-channel retailing.

70% of Brisbane’s large-tenant take-up has been to newly built space

New generation industrial buildings are best placed to provide the facilities and flexibility required to house specialised racking and picking systems increasingly deployed across both B2B and B2C distribution, incorporating the latest warehouse management systems and potentially the automated mobile robotic picking systems. Internal heights of 10m+, increased floor loading and all-weather awnings with flexible docks are all common features in new builds. The popularity of new builds, particularly for larger industrial users of 7,500sqm+ is clear to see, accounting for 70% of recent take-up across Brisbane.

The transport and warehouse sector continued to dominate tenant demand from tenants 7,500sqm+ with 33% of activity. Retail trade is also active in the larger tenant market, accounting for 30% of space leased, with fewer, but larger deals generally in evidence in the sector.

Appetite for new space will see speculative construction continue to grow

This demand for newly constructed industrial space is expected to remain strong despite the likely economic headwinds. There are three key reasons why speculative space will remain an attractive option for tenants, ahead of existing space and the pre-commitment process.

1. Low availability of existing large prime assets

While the overall Brisbane industrial vacancy is sitting only 7% below the 10 year average at 445,019 sqm, the availability of larger prime options is limited. As at the April 2020 survey there were only 7 prime options of 7,500sqm+ covering 67,768sqm. This is a 7-year low and 36% below the 10-year average, showing that this large, prime sector is outperforming the wider market. Currently available speculative space 7,500sqm+ has an average time on the market of just 4.0 months, compared to the market average of 10 months (prime = 4.7 months). Across all vacancy 3,000sqm+ the average time on the market is 15.2 months.

2. Attractive Rents

The sustained low yield environment for industrial assets, driven by the global low interest rates and accelerated appetite for industrial assets, assists developers to offer speculative product at competitive rental levels. As much of the larger speculative development is undertaken by institutional owners with existing land banks, for their own investment vehicles, the limited development margins and land input costs generally means the facility can be offered to tenants at a relatively small rental premium to existing prime assets.

3. Faster than pre-commitment process and able to adapt to shorter lease terms

Tenants with specialised building or locational requirements and/or larger lead times will continue to pursue a pre-commitment process. However, with lease terms 7+ years generally required for strong engagement with D&C developers, this does not suit all tenants, particularly the active Transport/3PL sector. Additionally, the pre-commitment and D&C process can be lengthy with not all tenants having the luxury of 9-12+ months of lead time to find new premises.

Speculative Construction for 2020 is already ramping up

With the level of available speculative space a relatively modest 55,888sqm (Apr 20) the development response to fulfil future demand is already underway. Dexus have commenced Stage 1 at Freeman Central, Richlands with 34,800sqm to be completed by August 2020. At Willawong, Stockland is constructing Stage 2 of Willawong Distribution Centre, a 25,428sqm facility. Additional speculative developments are also expected across the TradeCoast and Southern markets over the course of 2020 with developers Charter Hall, Fife Capital and local syndicators such as GARDA Capital active. Forecast to account for 35% of the total 2020 industrial supply (3,000sqm+) the amount of speculative space delivered to the market will be double the levels seen last year, with development plans appeared to be unchanged due to COVID-19.

Tenant acceptance of speculative development is high as Amazon’s recent lease of a 16,218sqm speculatively built facility in Lytton shows. Although upgrades to the property will be made to provide air-conditioning to the entire warehouse, upgraded power and increased staff parking, the underlying warehouse design suited their needs. Other major industrial users to have recently chosen speculative space include JBHiFi, Caroma, DHL, Boeing and CTI Logistics.

This high level of new generation building supply will accelerate obsolescence

With the investment environment remaining highly supportive of allocating funds into the industrial space, development remains a key strategy in increasing industrial funds under management and is expected to remain active in the near term. Yield support will assist to keep rents for new product in line with the existing market, enhancing tenant mobility and the upgrading of facilities across the market. Older stock without the key features logistics tenants now seek will face a reduced pool of tenants considering their asset and will have limited ability to retain or grow rental levels.

While Brisbane does not yet have the same middle ring residential development pressure as has been seen in Sydney, where industrial space has been displaced from former key industrial locations, the growing obsolescence of old facilities will accelerate this trend in the future.