Industrial real estate was the UK’s highest returning sector in 2017. MSCI’s Monthly Index recorded annual total returns for the sector of 21.1%. Around half of the total return was due to yield compression with a quarter each from rental growth and income. On the face of it this may imply that the prospects for further out-performance could be limited by high pricing and already realised capital growth. However, we firmly believe that parts of the warehouse/ logistics market still offer investment potential.
Industrial performance has been fuelled by the structural shift of retail spend from high street ‘bricks and mortar’ shops to the internet. Online spend now accounts for £1 in every £6 spent on retail in the UK having grown from £1 in every £20 a decade ago. This structural change in consumer spending habits has fostered huge occupational demand for warehouse/ logistics and caused investors to focus on the sector, forcing yields down and rents up. One third of all leasing deals last year were directly attributable to retailers. A further third were indirectly linked with third party logistics operators taking this space.
Despite the strong online growth that has already occurred, this trend has much further to run. PMA forecasts that the UK’s online spend will rise to 23% by 2022, equivalent to 10% growth every year between now and then. This means that the future performance prospects for warehouse/ logistics are bright. The market is competitively priced in yield terms but in parts it still offers savvy investors the chance to acquire stock at a reasonable price ahead of a likely occupational demand upswing and, therefore, capital growth.
Delivery speed, reliability and convenience are fast-becoming the major differentiators for customers choosing where to spend online. By virtue it is now a major battleground for retailers. Amazon’s new ‘Treasure Trucks’ concept is one example of how retailers are trying to gain an edge. These trucks will be parked for short periods in high footfall locations such as stations and shopping centres to offer click and collect and local order fulfilment.
That type of concept is not feasible for most operators though, at least not yet, which means they will need conventional real estate to offer rapid, dependable delivery or convenient collection. This necessitates responsive and extensive supply chains with greater weight given to the last mile delivery or, increasingly, the last hour delivery. We expect occupational demand will pivot towards maintaining centralised regional distribution hubs and smaller, local last hour hubs capable of offering rapid access to customers and being easily accessible by them. This will bring more emphasis on quality assets in smaller urban areas than have been targeted so far. These areas may be considered by many investors to secondary markets at the moment meaning that mispricing may occur.
It is our belief that other factors will also focus occupational demand on quality assets in these locations. Warehouse/ logistics is increasingly reliant upon technology and automation. Modern buildings use embedded sensors to monitor stock holdings and direct the increasing hordes of robotic workers. A typical warehouse for online food retailer Ocado, for example, will use thousands of robots to just 200 human employees. The reason? Efficiency. Robots are able to pick and pack a shopping order of 50 items within 5 minutes compared to a human time of up to 2 hours.
As a result, access to high-speed broadband and reliable power supply are gaining importance as locational drivers for occupiers. With the cost of automation continuing to fall and its capabilities rising, there will be a lower requirement for on-site human workers. This means that access to labour markets with high availability, a key consideration for most occupiers at present, will lose its significance. Quality warehouse/ logistics that benefits from access to reliable power, high-speed internet connections and which is situated within or close to urban locations in smaller markets is expected to benefit.
In summary, we see a continuation of the structural drive towards warehouse/ logistics fuelled by online retail growth. Greater priority will be given to urban warehouse/ logistics hubs within small markets which can fulfil growing customer expectations for quick delivery and convenient collection. This will combine with a lesser need for access to deep labour markets in favour of fewer but more skilled technicians and a greater need for power and broadband to drive occupational demand in some markets currently deemed to be secondary. Savvy investors who understand these trends and invest accordingly stand to benefit.
Senior Analyst - Investment Strategy and Risk