Industrial property – the silver lining in the retail cloud

August 2021

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Written by Per Amundsen, Head of Research, Thinktank

Those thinking that life for the retail sector will return to normal after COVID need to think again. E-commerce has a 26-year track record – Amazon sold its first book online in 1995 – and globally the online retail market is expected to total nearly $US5 trillion in 2021. All COVID has done is accelerate the pace and sophistication of growth.
What began with books has now spread across almost the entire the retail sector. With product and service choice growing exponentially, enhanced customer service (including returns) and delivery times slashed with consumer protections enhanced, sales have flocked to the web. Smartphones and tablets are integral to this e-commerce revolution as major brands ensure their websites are mobile-adaptive to better capture the Generation Z and Millennial markets.

Although this e-commerce revolution, when combined with COVID lockdowns, has adversely impacted on the bricks and mortar retail sector – “Thinktank’s Property Market Focus” August report notes that department stores and clothing and footwear have been the hardest hit – it has been a boon for industrial property.

A report by JLL, a global real estate services firm specialising in commercial property and investment management, estimates Australia’s industrial property sector will reach $120 billion by 2025 – a 25% increase on today’s $96 billion. Warehouses and other logistics facilities are springing up all over metro and non-metro locations as major property players such as Charter Hall, Goodman Group, Dexus and Mirvac carve a slice of the action.

According to the research, an extra 70,000 sqm of warehouse space is needed for every $1 billion increase in e-commerce sales. Even factoring in the COVID “sugar hit” on online sales, the $14 billion jump in e-commerce spending in the past year simply underlines why demand for industrial property is growing.

The latest National Industrial Report from Frank Knight simply amplifies the JLL message. It says: “The pandemic has catalysed e-commerce growth, further bolstering demand for industrial logistics. More than 1.3 million new households began shopping online since the start of the pandemic, and, according to Australia Post, almost half of this contingent have become regular online shoppers.

“At the height of the pandemic, online’s share of the total retail spend peaked between 11.1% and 16.3%. Since December (2020), retail has retained a share of total spend of around 9.2%” – a figure that’s almost certain to have grown due the current lockdowns in NSW and Victoria.

Frank Knight puts it succinctly: “Businesses are having to invest in their supply chain management and partner with suppliers, be it tech, distribution or storage capability to mitigate future capacity pressures. There has also been a significant in growth in suburban last-mile freight tasks due to the rise in online shopping.”

So, the message to investors in commercial property is clear cut – the industrial sector deserves serious consideration. At Thinktank, we certainly think so, having 29.2% of our loan portfolio as at 31st July 2021 in this asset. Yields are falling in most markets with Frank Knight expecting demand to remain robust. “With vacancy at record low levels, investors will increasingly be anticipating rental growth in coming years, leading to further downward pressure on yields in the near term.”

For those investors who are new to the sector, there are some commonly accepted guidelines for how to either invest directly or via a fund manager in this market. In many respects, the principles governing other commercial property sectors apply to industrial, although there are some nuances particular to this sector.

There are commercial property investment specialists who can identify and present relevant factors for investors to consider. Location remains paramount: which state or capital city? And which precinct in that city? Remember it’s crucial the area chosen has good access to major arterial roads and transport links to allow trucks easy access.

Genuinely understanding the leasing market is critical with every precinct having different tenant demand and lease profile. So, for your asset to appeal to the widest segment of the market, know those tenant characteristics before investing in an industrial property. In this respect it’s no different to other commercial property investment fundamentals: understand the vacancy rates and market rents alongside the broader macro themes prevailing in any given precinct.

Tenancy profile is important, with a strong performance history and operating sustainably through varying market conditions is essential while having a national and/or international presence is a bonus.

Typical industrial property lease terms range from three to 10 years, with annual rent increases either in line with CPI or a fixed percentage, often 3-4%. Rent should reflect the benchmark level for that precinct and set accordingly. An independent property valuation will offer essential insights on this among other factors pertinent to the property, location and typical tenancy profile.

Other considerations include tenants requiring specialised equipment (the appeal to a niche market must be offset against a smaller pool of potential tenants), meeting tenant needs (i.e. significant roof and gantry height) and gentrification, meaning the precinct could be evolving towards a different property classification which is precisely what we have observed with swathes of urban B and C Grade office buildings being converted to medium density residential living.

Investing in industrial property is no different to any other investment – good research will pay dividends (no pun intended) and, for investment novices in particular, getting specialist advice should be high on the agenda.

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Disclaimer
This article is for informational purposes only and does not constitute a product recommendation, taxation or financial advice and should not be relied upon as such.