Industrial Occupier Demand Runs Strong

Occupier demand for industrial property, across all capital city markets, picked up strongly through the 2022 financial year with take-up running well above long run averages or close to record levels.

Common themes are evident across most industrial regions. The strength of demand was driven by strong state economic rebounds from pandemic related disruptions, as well as pandemic boosted trends including rapid online sales growth and businesses taking extra inventory storage space to counter supply chain disruptions.

On the supply side, completions are running well above average in Sydney, Melbourne, Brisbane and are picking up in Perth and Hobart, but are well below average in Adelaide, Canberra and Darwin. The delivery of projects in all markets are suffering to varying degrees from labour and material shortages, which are pushing construction costs higher.

The strength of occupier demand has outpaced completions in Sydney, Melbourne, Brisbane, Adelaide, Perth, Hobart and Canberra, pushing vacancy rates to very low levels. This has driven a strong rental response and winding down of leasing incentives, which in a number of markets are close to zero. Cost pressures flowing through from higher land values and construction costs are pushing up pre-lease rents adding further upward pressure to market rents.

The weight of funds chasing industrial property drove yields down to historically low levels over the 2022 financial year, underpinning exceptional property price gains in most markets. However, the rising cost of debt, flowing through from higher bond rates caused investors to pause more broadly in during the second quarter of 2022, however, we are yet to see concrete evidence of yields softening. We expect occupier demand for industrial property to remain strong in most markets over the next 12-months before pandemic related drivers start to ease. On our forecasts, the rate of online spending growth will slow as spending on goods tilts back towards services and we do not think the shift towards storing higher local inventories will be enduring, once supply chain disruptions ease.

Beyond the next 12 to 18 months, our forecasts are for vacancy rates to drift higher across the eastern seaboard markets as supply takes time to adjust to demand. We expect economic growth in South Australia, the Northern Territory, the Australian Capital Territory, Western Australia and Tasmania to all slow to varying degrees in the short-tomedium term, pointing to moderating industrial occupier demand.

Near term rental growth prospects are positive across all markets, reflecting tight vacancies but also rising costs flowing through from the prelease market, that were previously absorbed using firming yields. The duration of strong rental growth depends, market by market, on how long rising construction levels take to surpass slowing occupier demand and push vacancies higher.

Industrial property yields are expected to soften across most capital city industrial property markets from the end of 2022, as the impact of higher bond rates flows through. This will end an extraordinary period of yield firming. However, rising rents will continue to drive solid capital value gains over the short to medium term.

Mathew Tiller Head of Research, LJ Hooker Group