Why the industrial & logistics sector is set to remain resilient regardless of Covid-19
It is extraordinary to think how much the world has changed since Savills last Big Shed Briefing market update at the start of 2020. Covid-19 and the subsequent lockdown threw up a number of unprecedented challenges, many of which have proven just how essential the UK industrial and logistics sector is to our daily lives.
In many respects supply chains have been tested to the limit, initially to feed the nation and provide essential services to cope with the pandemic, before ensuring that consumers could still make other non-essential purchases via online platforms. As we continue to adapt to this new normal, some interesting statistics are emerging providing evidence that the shift to online retail is set to rise more rapidly than earlier forecasts ever expected. Online now accounts for 33% of all retail sales, up from 21% at the start of the year. In fact, should this rate of growth continue over the next 12 months, an additional 14.9 million sq ft of warehouse space will be required to service normal levels of demand.
However, even if this uptick doesn’t materialise, online retail already accounts for 19.2p in every pound spent in the shops. What’s more, forecasters now suggest that we could see this increase to as much as 28p by 2024.
Peace of mind
Consequently, logistics real estate is benefiting from this behavioural shift, which is reflected in the half-year take-up figures. Take-up for H1 2020 reached 22.4 million sq ft, the best on record, 38% above 2019 and 66% above the long term average. It is also interesting to note that just 11% was for deals where the lease is less than 12 months due to Covid-19, substantially lower than initial predictions.
On the supply side, the market paints a very different picture to where it was at the time of the last Global Financial Crisis (GFC), which should provide some peace of mind.
Then, almost 100 million sq ft of warehouse space was available, reflecting a vacancy rate of close to 25%. Today, supply is just over 36 million sq ft with levels of vacancy at 6.58% or less in many parts of the country.
There is also just 6.25 million sq ft of speculative development under construction due for delivery in 2020. Those underway are set to continue, but we are not anticipating any new speculative announcements in the short-term.
Speculative development Given the economic climate, a key metric to monitor will be levels of second hand supply, as this could point to a rise in tenant defaults. Whilst too early to be defined as a trend, the level of supply for grades B and C stock has risen by 9% to 17.46m sq ft in the past six months.
Although a cause for concern, it should be noted that over 40 million sq ft of new supply would be required to see vacancy levels rise to 12% – a tipping point for rental growth to stop.
The recent prudent levels of speculative development will help to offset an increase in vacancy arising from tenant default. Some regions in the UK now have no big shed speculative development under construction whatsoever. Consequently, it is highly unlikely that vacancy rates will return to post GFC levels. Furthermore, Savills research has created a model that projects vacancy rates going forward within various parameters, and even in a downside scenario where we assume over 15 million sq ft of supply will return to the market, vacancy rates rise to just 11.4%, ... which is still below the aforementioned 12% tipping point.
Looking forward, as the lifting of restrictions moves into its next phase, we expect the market will also perform differently when compared to the immediate aftermath of lockdown. On the demand side, requirement levels have rebounded sharply after a slow April and early May, but this lag should mean that take-up for ‘churn stock’ in H2 is slower than normal.
Furthermore, as government support comes to an end in the autumn, consumer confidence is likely to fall. Bearing in mind that almost two thirds of demand is related to retail, it is unlikely that the current levels of take-up will be sustained. This is despite the growth of online shopping increasing at levels not seen since 2008.
The investment market has also been affected by Covid-19. Capital markets all but ceased during the height of lockdown as investors struggled to undertake due diligence and underwrite rental growth assumptions. However, as it became clear that inspections and surveys could be carried out whilst maintaining social distancing and that occupiers were still taking space at pre-Covid rental levels, confidence returned, and the rate of transactions continued to increase.
Given the market turbulence across all sectors and high levels of uncertainty, it is encouraging to report that logistics investment volumes have reached £1.12bn for H1, a fall of just 26% when compared with H1 2019.
In terms of pricing, during lockdown Savills prime yields have moved out 25bps and now stand at 4.50% for prime single let logistics units and 4.25% for multi-let industrial estates. However, as lockdown has been eased and market activity has returned, positive sentiment and competitive tension is again putting negative pressure on these yields.
Throughout this period one thing has remained certain, that industrial and logistics is still a top pick for investors, especially due to the expectation that it will continue to be resilient and outperform in the current market.
More generally, the pandemic has indeed tested supply chains to their limits. The current ‘just-in-time’ model has little resilience, which has prompted a shift towards more of a ‘just-in-case’ scenario. As a result, we have seen an uptick in companies seeking to build in extra ‘safety stock’ in order to mitigate future supply chain risks, leading to more warehouse demand. Further to this, we have begun to see global supply chains come under review with a move towards near-shoring. This should increase demand for space closer to the consumer market.
Automation and robots Finally, we have seen Covid-19 stimulate a reliance on labour, whilst simultaneously securing efficiency gains. The shift towards automation will impact the specification of buildings and their locations as there will no longer be a requirement to locate near large labour pools, but rather a heightened need for sites which have access to power.
Ultimately, the sector has proven remarkably rise in companies seeking to increase their resilient in the face of Covid-19 and its use of automation and robots for warehouse strong fundamentals should ensure it stays and transport operations to reduce their that way despite future uncertainty.
Will Laing, Savills research analyst.