Research Report

MULTI-LET The definitive guide to the UK’s multi-let industrial property market Summer 2018

International Property Consultants

Multi-let: Summer 2018

CONTENTS Introduction 3 Contributors 4 Multi-let: at a glance

5

Definitions and Market Structure

7

• Location and Value of Estates • Sample Breakdown

8 10

Who are the Occupiers?

13

Income 25 • Rents • Incentives • Incentives and Underrentedness • Logistics

26 30 34 36

Length of Income

39

Security of Income

43

• Void Rates • Tenant Churn • Breaks, Expiries and Defaults

44 46 50

Investment 55 Reference Tables

60

Glossary 62 Contacts 65

Authors Ben Clarke Senior Associate Tel. +44 (0)20 7333 6288 bclarke@geraldeve.com

Steve Sharman Partner Tel. +44 (0)20 7333 6271 ssharman@geraldeve.com

Introduction

INTRODUCTION I am delighted to be able to bring this research back and I hope it shows you just how seriously we take the UK multi-let industrial market. With 10 years of annual data, 15 contributors, and over 30,000 individual units in our sample, this is the largest and most detailed syndicated study, perhaps of any commercial property asset class, in the market today.

We believe that understanding the nature of occupier demand is crucial. To this end, we have set out to investigate the inner workings of this sector and to answer some of the market’s more burning questions. Who occupies this space and why? What impact is the ‘urban logistics’ model having in real terms? Does this cycle have further to run? What are the occupational opportunities and threats? We feel we can confidently answer these questions on this, one of the least-understood property classes.

We have information on exactly who the occupiers are, where they are located, what they do, how much space they occupy and for how long. We have information on the relative sizes of estates and the impact this has had on performance. We know how many units are on each site, what the incidence of tenant ‘churn’ is and what the default and void rates are.

Such detailed knowledge has allowed us to investigate how income is changing in the market (including where and from which occupiers) along with analysis of over and under-renting and the use of rental incentives. Such analysis is crucial to determining real value and unlocking the potential of this asset class.

With the most comprehensive and granular data, Gerald Eve can offer the most insightful trend analysis in the market and the tools to offer a reliable view on future performance.

With this new research, we can undertake detailed analysis on a regional and local level, which when combined with our Prime Logistics research, enables our clients to use our data to meaningfully underwrite industrial asset performance across any size bracket.

Of course, none of this analysis would be possible without our contributors. We are very grateful to them for agreeing to be part of this study and for providing so much strategic input at the start of the process. We look forward to continuing to work with you in this sector.

John Rodgers Partner, Head of Capital Markets Tel. +44 (0)20 3486 3467 Mobile +44 (0)7810 307422 jrodgers@geraldeve.com

With this new research, we can undertake detailed analysis on a regional and local level, which when combined with our Prime Logistics research, enables our clients to use our data to meaningfully underwrite industrial asset performance across any size bracket.

3

Multi-let: Summer 2018

CONTRIBUTORS With thanks to our contributors, without which this essential research would not be possible.

4

Multi-let: at a glance

MULTI-LET: AT A GLANCE Average UK rent

Rental growth over past 5 years

Average unit size

ÂŁ9.81

32%

6,086

UK void rate

Average lease term

6.7%

7.5

Average time to first break

Retail-related and logistics* occupied floorspace

Manufacturing occupied floorspace

5.5

43%

28%

Tenant churn rate

Tenant default rate

Tenant retention rate at lease expiry

14%

3.6%

67%

per sq ft

Average estate size

68,500 years

sq ft

sq ft

years

* Trade counters/wholesalers, retail & business storage and logistics

5

Definitions and market structure

DEFINITIONS AND MARKET STRUCTURE DEFINITIONS

This report covers industrial units between

up to a maximum lease length of

500 50,000

30

sq ft and

sq ft in size

years

MULTI-LET: 2017 DATASET

1,035

11,539

70.2

Estates

Units

Million sq ft

£10.2bn

38%

£495m

Total capital value

of the MSCI standard industrial universe

Annual rent roll

7

Multi-let: Summer 2018

LOCATION AND VALUE OF ESTATES To get a sense of the multi-let industrial landscape as at the end of 2017, see below the location of the estates in the study across the UK. The estates are distributed widely, but there is clustering around major cities and a heavy concentration in London and the South East.

Regional rental value (OMRV) Over £75m £50m-£75m £25m-£50m £20m-£25m £15m-£20m Below £15m Estates

* Inner London postcodes E, EC, N, NE, NW, SE, SW, W, WC.

8

The UK Government-defined regions are indicated on the map below, showing the total multi-let Open Market Rental Value (OMRV) achievable in each area. Values are also particularly heavily weighted towards London and the South East.

Greater London and Inner London* regional boundaries

Location and value of estates

In London and the South East, units are, on average, just under 10,000 sq ft in size, whereas in the rest of the UK they are typically under 5,000 sq ft.

The South East dominates the multi-let industrial sample. Here there are more individual units than any other region, along with the largest share of OMRV. Combined with Inner and Greater London there is a greater amount of total OMRV here than the rest of the UK combined.

Regional proportion of individual units Source: Gerald Eve

East Midlands 5%

9% Yorks/Humber

East of England 6% 10% West Midlands Greater London 10%

5% Wales

Outside of the South East, we can see that rents are lower and units tend to be smaller. In London and the South East, units are, on average, just under 10,000 sq ft, whereas in the rest of the UK they are typically under 5,000 sq ft.

Consequently the North East, with an average unit size of just over 3,000 sq ft and an OMRV per sq ft of £5.29, accounts for almost as many individual units as the South East, but only a fraction of the total OMRV. Conversely, Inner London, with an average unit size of over 10,000 sq ft and OMRV per sq ft of £14.52, has the smallest number of individual units but the third highest share of total OMRV. With relatively small units, cheap rental valuations and low numbers of individual units, Wales and the East Midlands account for little multi-let industrial activity and less than 2% of the total OMRV each.

Inner London 5% 5% South West North East 12%

12% South East

Unit sizes and rents by region Source: Gerald Eve

North West 11%

9% Scotland

Regional proportion of OMRV Source: Gerald Eve % of OMRV

000s sq ft

£ per sq ft

12

15

10

13

8

11

6

9

4

7

2

5

0

3 Wales

East Midlands

Yorks/Humber

North East

Scotland

West Midlands

20

North West

30

South West

Inner London

40

Esat of England

50

South East

60

Greater London

70

10 Average unit size (sq ft) (LHS) OMRV per sq ft (RHS)

0 London and the South East South East Greater London Inner London

West Midlands East of England North West Scotland North East

Rest of UK Yorks/Humber South West East Midlands Wales

9

Multi-let: Summer 2018

SAMPLE BREAKDOWN UNITS Taking the sample as a whole, a large proportion of units are at the smaller end of the scale. Almost two thirds of the units in the sample are under 5,000 sq ft.

These smaller units have a much higher representation in cheaper areas outside of the South East, so when the sample is broken down by unit size and weighted by total OMRV the distribution is much more even – also by virtue of the fact that the larger units occupy more floorspace.

Unit sizes: proportion by count

Unit sizes: proportion by OMRV

Source: Gerald Eve

Source: Gerald Eve

4%

2%

25,000-50,000 sq ft

500-1,000 sq ft

12% 500-1,000 sq ft

13% 10,000-25,000 sq ft

19%

18% 25,000-50,000 sq ft

16%

31%

5,000-10,000 sq ft

11% 1,000-2,500 sq ft

2,500-5,000 sq ft

1,000-2,500 sq ft

28% 10,000-25,000 sq ft

21%

25% 5,000-10,000 sq ft

2,500-5,000 sq ft

Inner London tends to have more large estates comprised of fewer, larger units.

10

Sample Breakdown

ESTATES In terms of the overall size of estates, the 100,000 - 250,000 sq ft multi-let industrial estate is the most prevalent in the sample.

Wales, the North East and Scotland account for the smallest

estates of up to 25,000 sq ft but the South East dominates at all other sizes. Greater London and the West Midlands also feature when considering the very largest estates.

Distribution of multi-let estates by size Source: Gerald Eve

35%

25%

16%

14%

6%

up to 25,000 sq ft

4%

25,000 sq ft 50,000 sq ft

50,000 sq ft 100,000 sq ft

100,000 sq ft 250,000 sq ft

250,000 sq ft 500,000 sq ft

500,000 sq ft 1,000,000 sq ft

• South East

• South East • Greater London

• South East • Greater London • West Midlands

Regions most associated with these estate sizes

25 20 15 10 5 0 81-140 units

For a more detailed numerical breakdown, please see the Reference Tables.

% 30

41-80 units

For several elements of the analysis, the 3.9% of estates that consist of only one unit are excluded so as to include only truly multi-let estates.

Source: Gerald Eve

21-40 units

Unsurprisingly, there tends to be a straightforward positive relationship between estate size and the number of units on an estate. Most regions follow this profile, with exceptions being that Inner London tends to have more relatively large estates comprised of fewer but larger units, and the North East tends to have relatively smaller estates with a greater number of smaller units.

Distribution of units per estate

11-20 units

There is a broad distribution of numbers of units on each estate, with the most frequently occurring being between 11 and 20 units.

6-10 units

• South East

2-5 units

• South East • Greater London

1 unit

• Wales • North East • Scotland

11

Multi-let: Summer 2018

MARKET STRUCTURE SUMMARY • Estates are distributed widely across the UK, with a clustering around major cities and a heavy concentration in London and the South East.

• This is particularly pronounced in value terms – there is greater total OMRV in London and the South East than the rest of the UK combined.

• Almost two thirds of the units in the sample are under 5,000 sq ft.

However, this accounts for only 29% by total value, since the larger units are more concentrated in the relatively expensive South East.

• Estates with a total size of 100,000 – 250,000 sq ft are the most common. Wales, the North East and Scotland account for the smallest estates of up to 25,000 sq ft, but the South East dominates at all other sizes.

12

WHO ARE THE OCCUPIERS? KEY QUESTIONS • How has the multi-let industrial occupier base changed over the last 10 years?

• Are there regional differences in the multi-let industrial occupier base?

• Do certain occupier sectors occupy different sizes of unit?

• Do particular occupier sectors tend to cluster and, if so, where?

13

Multi-let: Summer 2018

WHO ARE THE OCCUPIERS? Distribution of business activities by floorspace Source: Gerald Eve

ALL UK

23%

9%

17%

Trade counters /wholesalers

Logistics

General manufacturing

11%

5%

Retail & business storage

Food manufacturing

43% Retail-related and logistics

5% On-site servicing

2%

2%

Leisure

Individuals

6%

7%

13%

High tech engineering

Off-site services

Quasi -office/ archiving

28%

12%

17%

Manufacturing

Services

Other

LONDON AND THE SOUTH EAST

25%

14%

14%

5%

4%

Trade counters /wholesalers

Logistics

General manufacturing

High tech engineering

On-site servicing

9%

6%

Retail & business storage

Food manufacturing

48% Retail-related and logistics

1%

1%

Leisure

Individuals

5%

16%

Off-site services

Quasi-office/ archiving

25%

9%

18%

Manufacturing

Services

Other

REST OF UK

22%

5%

Trade counters /wholesalers

Logistics

6%

6%

General manufacturing

High tech engineering

On-site servicing

12%

5%

Retail & business storage

Food manufacturing

39% Retail-related and logistics

14

20%

2%

3%

Leisure

8%

11%

Off-site services

Quasi -office/ archiving

31%

14%

16%

Manufacturing

Services

Other

Individuals

Who are the occupiers?

RETAIL-RELATED AND LOGISTICS OCCUPIERS DOMINATE At the end of 2017, the largest proportion of multi-let industrial floorspace by business activity was that related to retailing and logistics. Trade counters, retail & business storage and dedicated logistics accounted for 43% of occupied floorspace.

Varying types of manufacturing accounted for 27% of the floorspace in the sample. This includes food manufacturing, more general manufacturing and high tech engineering.

These are the two main segments of multi-let industrial occupation, with smaller segments of quasi-office/archiving (from financial and legal firms, public sector bodies and estate agents etc) on 13%, with on-site serving (i.e. MOT centres) and off-site servicing (i.e. plumbers, joiners) collectively on a similar proportion.

In much smaller numbers are the leisure occupiers (i.e. gyms, soft play, trampoline warehouses) and private individuals (no company name on the lease) on around a 2% share each.

The same breakdown for London and the South East, and the rest of the UK reveals geographical disparities. Logistics floorspace accounts for far more in London and the South East than elsewhere (14% against 5%). Indeed, retail-related and logistics as a whole is more prominent, while the reverse is true for manufacturing and on and off-site services. The use of multi-let industrial space for quasi-office/archiving purposes is also more significant in London and the South East.

Most business activities are heavily represented in the South East in floorspace terms, due to both its size and concentration of multi-let industrial space generally. However, some regions have a relatively high or low concentration of the different multi-let industrial business activities, according to their size and compared to the national average.

Concentration of business activity by region Source: Gerald Eve

Scotland High concentration of general manufacturing and individuals Low concentration of logisitics and retail & business storage North East High concentration of high tech engineering and individuals Low concentration of logistics

Yorkshire and The Humber Low concentration of logistics and trade counters/wholesalers North West High concentration of off-site services Low concentration of trade counters/wholesalers Wales High concentration of general manufacturing Low concentration of retail & business storage

South West Low concentration of logistics and retail & business storage

Greater London High concentration of logistics operators

Inner London High concentration of food manufacturers and quasi-office/archiving Low concentration of general manufacturing South East High concentration of logistics operators

15

Multi-let: Summer 2018

WHO ARE THE OCCUPIERS? REGIONAL DIFFERENCES IN OCCUPIER BASE Inner London has a heavy concentration of food manufacturing by floorspace and over a third of all national multi-let industrial food manufacturing rental income comes just from the Inner London postcodes. These units create produce for London’s dense population, coffee shops and restaurants, and include niche, boutique-type small batch brewers, bakers, coffee roasters, chocolatiers and canape caterers.

Inner London is also host to a disproportionately large amount of quasi-office/archiving activity and almost two thirds of multi-let industrial rental income for this business activity comes from London and the South East. Multi-let industrial provides a far cheaper alternative to expensive office lets for essential back office and administration activities, as well as archiving for financial and legal firms, estate agencies and public sector bodies.

Dedicated logistics is, unsurprisingly, a leading segment in Greater London and the South East, linked to the major transport nodes bringing goods into and out of the country and onwards to the rest of the UK. Over 80% of all UK multi-let industrial logistics rental income is generated in London and the South East.

The North East units in our sample, while unsurprisingly underrepresented by logistics occupiers, have a relatively high concentration of high tech engineering occupiers. The region accounts for 8.8% of all UK high tech engineering MLI space – the largest outside of London and the South East. Our sample size here for the North East is small, arguably in part because the lower cost means this region hosts a relatively high proportion of non-institutional investors. The very best institutional-grade stock in the region is accounted for in our sample and thus it contains a relatively high proportion of the engineering activity associated with the prominent automotive and sustainability sectors in the region.

Scotland and the North East are relatively overweight in lettings to individuals, which ties in with the prevalence of relatively smaller units in those areas.

Total logistics OMRV by broad geography Source: Gerald Eve % 90 80

We also believe the wealth and density of Greater London and its earlier adoption of internet retailing (and other factors such as lower car ownership and a higher proportion of millenials) has generated greater demand for the movement of goods to end-users and is setting the trend.

Yorkshire & the Humber is relatively underweight in trade counter activity, and the more provincial locations of Scotland, the South West and Wales have a relatively low concentration of logistics operators and retail & business storage, which reflects their relative inaccessibility and lower population concentration. These types of locations, notably Wales, are relatively overweight in general manufacturing.

70 60 50 40 30 20 10 0 London and the South East

Rest of UK

Dedicated logistics is, unsurprisingly, a leading segment in Greater London and the South East, linked to the major transport nodes bringing goods into and out of the country, and the servicing of London's end-user population. Over 80% of all UK multi-let industrial logistics rental income is generated in London and the South East.

16

17

Multi-let: Summer 2018

WHO ARE THE OCCUPIERS? THE MULTI-LET OCCUPIER BASE IS EVOLVING The multi-let industrial occupier landscape is a dynamic one and the current breakdown of occupied space by business activity is relatively recent. Over a 10 year timeframe we have seen the evolution of multi-let industrial from being majority occupied by general manufacturers to be overtaken by activities related to retailing.

Trade counters/wholesalers and general manufacturing are the two largest individual multi-let industrial business activities by floorspace.

In 2008, general manufacturing was dominant, accounting for around a quarter of all multi-let industrial floorspace. A steady decline since then combined with an upsurge in trade counter/ wholesaler-occupied space, particularly since 2014, has effectively reversed the relative proportions.

Business activity, proportions of occupied floorspace, all UK

Manufacturing occupiers, proportion of multi-let industrial floorspace Source: Gerald Eve % 40

35

30

25

20

Source: Gerald Eve 15

%

2008

25 24

2009

2010

2011

2012

2013

2014

2015

2016

2017

General manufacturing Food manufacturing High tech engineering

23 22 21

Occupiers more broadly related to the retail sector – trade counters/wholesalers, retail & business storage and logistics operators – have collectively trended upwards in terms of their proportion of occupied multi-let industrial floorspace.

20 19 18 17

Retail-related occupiers, proportion of floorspace

16

Source: Gerald Eve 2009

2010

2011

2012

2013

2014

2015

2016

2017

Trade counters/wholesalers General manufacturing

% 50 45

Taking manufacturing occupier activity more broadly, we can see how high tech engineering occupied space has also declined, though to a lesser extent than general manufacturing.

40

However, this shift for smaller multi-let industrial units is not necessarily a negative reflection on the manufacturing industry as a whole, since Gerald Eve observed an actual increase in manufacturing take-up of industrial units of greater than 50,000 sq ft in 2017, so it may be that tenants are up-sizing. Also the proportion of multi-let industrial floorspace allocated to the manufacture of food has increased somewhat over the past 10 years, buoyed by activity in Inner London.

30

9%

2008

35 5%

15

25 20 15 2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Trade counters/wholesalers Retail & business storage Logistics

The multi-let industrial sector as a whole has become more institutional in nature and has moved away from noise and waste-creating physical activity to lighter/cleaner storage, distribution and administration.

18

Who are the occupiers?

Business activity, proportions of occupied multi-let industrial floorspace

43%

Source: Gerald Eve % 45

of the market is occupied by retail-related and logistics occupiers

40

35

They are relatively different segments and have different planning use classes, but multi-let industrial to some extent provides a cheaper alternative to retail warehousing for trade counter-type occupiers.

At the end of 2017 the UK-wide OMRV for multi-let industrial trade counters/wholesalers was ÂŁ10.36 per sq ft. However, MSCI data suggest retail warehousing rent was significantly more expensive at ÂŁ17.81 per sq ft.

30

25 2008

2010

2011

2012

2013

2014

2015

2016

2017

Manufacturing Retail-related and logistics

Trade counter and retail warehousing OMRV per sq ft Sources: Gerald Eve, MSCI

2009

Smaller segments, such as on-site and off-site services and quasi-office/archiving activities have showed similar divergent trends as the multi-let industrial sector as a whole has moved away from noise and waste-creating physical activity to lighter/ cleaner storage, distribution and administration.

ÂŁ per sq ft 10.5 10.0 9.5 9.0

Business activity, proportions of occupied multi-let industrial floorspace

8.5

Source: Gerald Eve

8.0

%

7.5

14

7.0

13

6.5 12

6.0 2014

2015

2016

2017

Trade counters/wholesalers OMRV Discount to retail warehouse OMRV

The chart above shows how the margin between the two has been eroded in recent years though, and we will explore rental income further in the next section.

11 10 9 8 7

Dedicated logistics operators have also seen a near doubling in multi-let industrial floorspace, from 5% in 2008 to 9% in 2017. Taking all retail-related segments and all manufacturing-related segments together, we can see that both accounted for around a third of all occupied multi-let industrial space in 2008 before they diverged, to make retail the driving occupier force in multi-let industrial today.

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Services Quasi-office/archiving

19

Multi-let: Summer 2018

WHO ARE THE OCCUPIERS? REGIONAL TIME LAG IN CHANGING OCCUPIER BASE These trends are broadly observed across the disaggregated UK regions, though regions outside of the South East have a far higher legacy proportion of general manufacturing occupiers. For the rest of the UK it was only in 2017 that trade counters/wholesalers overtook general manufacturing as the dominant occupier segment – six years later than in London and the South East.

Business sector occupancy: London & South East

Business sector occupancy: Rest of UK

Source: Gerald Eve

Source: Gerald Eve

%

%

28

32

26 24

27

22 20

22

18 16

17

14 12

12 2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2008

General manufacturing Trade counters/wholesalers

2009

2010

2011

2012

2013

2014

2015

2016

2017

General manufacturing Trade counters/wholesalers

The emergence of trade counters/wholesalers as the dominant multi-let occupier type was seen much earlier in London and the South East, with a time differential of around 6 years compared to rest of the UK. The main question looking forward, is whether retail-related multi-let industrial occupiers will continue to take an increasingly large proportion of space and further crowd out more traditional manufacturing. The trend is in part linked to the rapidly changing ways that we work, shop and consume – particularly the logistics and retail storage element of demand.

Comparing the proportion of retail spend that now occurs online to the proportion of retail-related and logistics multi-let industrial activity suggests that retail will continue to trend upwards for at least the next few years. At what point the proportion of online activity plateaus and also whether the growth in retail multi-let industrial decouples from this anyway as the necessary logistics infrastructure is deemed sufficient has yet to be seen.

A potential moderating factor for the trade counter element of multi-let industrial demand is set to come about as rents continue to increase and close the gap with other more traditional forms of retail – and thus reducing its attractiveness as a potential alternative for occupiers.

20

Multi-let industrial retail-related and logistics occupation, and online retail spending Sources: Gerald Eve, ONS % 20

% Forecast

18

46 44

16

42

14

40

12

38

10 8

36

6

34

4

32

2

30

0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Proportion of retail spending online (LHS) Proportion of retail-related and logistics multi-let industrial occupation (RHS)

Who are the Occupiers?

21

Multi-let: Summer 2018

WHO ARE THE OCCUPIERS? Only a small proportion of estates are dominated by one type of business activity, but having at least a 30% major share is very common.

UNIT SIZES FOR DIFFERENT OCCUPIERS In terms of the size of units occupied, there is a clear distinction for logistics operators, occupying on average 13,500 sq ft in 2017, and individual traders, occupying only 2,600 sq ft. The other activities fall between these sizes, with the more space-intensive archiving and manufacturing at one end and the somewhat less space-intensive servicing and repair at the other.

Average unit size by business sector Source: Gerald Eve

We also analyse how dominant with one business activity or how diverse with multiple activities any individual multi-let industrial estate is. We consider a diverse estate to be that with more than five different types of business activity. An estate with a major business sector occupies 30%+ of the floorspace. A majority business sector occupies 50%+ and we consider a more specialist dominant one to have 75% or more of the floorspace attributable to only one business activity.

The prevalence of these factors, as a proportion of estate floorspace, is as follows:

000s sq ft 14 12

Estates with occupier sector specialisation and diversity Source: Gerald Eve

10

%

8

90 80

6

70 4

60

All business sectors

Individuals

On-site servicing

Off-site services

Leisure

Retail & business storage

High tech engineering

Food manufacturing

Trade counters/wholesalers

40 General manufacturing

0 Quasi-office/archiving

50

Logistics

2

30 20 10 0 Dominant

Majority

Major

Diverse

Only a small proportion of estates are dominated by one type of business activity, but having at least a 30% major share is very common. The breakdown of which business activities these tend to relate to is essentially the same, whether it is accounting for dominant, a majority or major share. The breakdown of the majority share is shown overleaf.

22

Who are the occupiers?

In terms of the size of units occupied, there is a clear distinction for logistics operators, occupying on average 13,500 sq ft in 2017, and individual traders, occupying only 2,600 sq ft.

Estates with a majority business activity

Proportion of diverse estates by region

Source: Gerald Eve

Source: Gerald Eve

%

%

25

55 50

20

45 40

15

35 30

10

25 5

20 15

0

Trade counters/wholesalers Traditional manufacturers

Estates with more agglomerated occupiers are much more likely to be retail-related tenants. Within that, trade counters/ wholesalers are the driving factor, with a higher proportion of majority trade counter estates than all types of majority manufacturing put together. It is no surprise to see clusters of trade counters, and some occupiers themselves actively encourage this by putting multiple brands on the same estate.

Of the manufacturers, it is the general manufacturers that are more often found on an agglomerated estate. This may be supply chain related, or because of groupings around dominant manufacturers such as is prevelant in the automotive industry, and the specialist skillsets required.

UK

Wales

East of England

Scotland

East Midlands

South East

Greater London

North West

London

Yorks/Humber

South West

West Midlands

North East

Other

Quasi-office/archiving

Services

Manufacturing

Retail and logisitcs

10

Larger estates Average size estates Smaller estates

In terms of diversity, the North West and the West Midlands have a significantly higher proportion of estates with five or more tenants, at around half of all estates. Typically you might expect those regions with the larger estates have more scope to house a larger variety of business activities, but the North East, Yorks/ Humber and Wales have a notably large amount of very diverse estates compared to their relatively small average estate size.

Conversely, London and the South East have much larger estates but tend to be less diverse.

23

Multi-let: Summer 2018

WHO ARE THE OCCUPIERS? SUMMARY • The multi-let industrial sector as a whole has shifted from noise and waste-creating physical activity to lighter/cleaner storage, distribution and administration. This is due in part to growing e-commerce and as multi-let industrial units take on a relatively more urban location as cities grow around them.

• Retailing-related and logistics occupied space increased from 33% of the total in 2008 to 43% in 2017. During the same period, the share of manufacturing-type occupiers fell from 36% of all floorspace to 28%.

• These trends are broadly observed across all UK regions, though regions outside of the South East have a far higher legacy proportion of general manufacturing occupiers.

• Logistics operators typically occupy much larger units than other business activities, taking an average 13,500 sq ft, compared to the all-business activity average of around 6,000 sq ft. London and the South East is key for this segment, generating over 80% of all logistics rental income.

• Retailing-related and logistics occupiers cluster together on a site more frequently than the other main activities. Within this, trade counters/wholesalers tend to agglomerate the most.

24

INCOME KEY QUESTIONS • What is the average rent of multi-let industrial units and how has this changed?

• Which occupier sectors occupy the most expensive units?

• Are there any estate characteristics which positively affect the rental profile?

• What are the average levels of incentives agreed on multi-let industrial units?

• Are certain occupier sectors more incentivised than others?

• Are there differences in the over or underrentedness of certain occupier sectors?

25

Multi-let: Summer 2018

INCOME: RENTS RISING VALUATIONS AND THE DECOUPLING OF LONDON AND THE SOUTH EAST In this section, in addition to OMRV we frequently refer to contracted rent and passing rent. Contracted rent is that stipulated in the contract and may be above or below the OMRV if the unit is over or underrented. The passing rent is that which is actually being paid to the landlord at a given point in time. This may be below the contracted rent if rental incentives are in place. Where an average has been ‘weighted’ it is to take into account the size and rental value of the underlying assets and give relatively higher weighting to those that are larger/worth more.

The weighted average OMRV has been on an upward trajectory since 2011 and was £9.81 per sq ft at the end of 2017. This figure is skewed upwards by the significantly more expensive rents in London and the South East.

UK weighted OMRV

Weighted OMRV by UK region

Source: Gerald Eve

Source: Gerald Eve £ per sq ft

£ per sq ft 10.0

16 £9.81

9.5

14

9.0

12

8.5

8

7.5

6

7.0

4

6.5

Multi-let industrial rents across the UK have increased by almost a third in the past five years. However, this has not occurred uniformly. Not only are London and the South East more expensive than the rest of the UK, market rents in these areas have been growing more strongly and have thus been decoupling from elsewhere. OMRVs in Inner London have grown at almost double the rate of those outside of the South East.

OMRV 2012 – 2017 by UK region OMRV £ per sq ft Rest of UK +22% South East +30% Greater London

Inner London +38% UK +32%

2012

2017

9

Wales

East Midlands

We anticipate that, over the next five years, these factors will continue to have an effect and a further decoupling will move rents in London and the South East to more than double that valued elsewhere, with a premium of 112% by 2022.

+37%

6

The premium for London and the South East over the rest of the UK was 81% in 2012, which pushed out to 95% in 2017. The growth in wealth has been noticeably stronger in the South East during this period and we have also seen strong population growth. This population is higher income-earning and arguably has a greater propensity to spend online than in other UK regions and is more likely to pay a premium for convienence.

This has been set against a greater contraction in multi-let industrial floorspace in London and the South East than in other areas, given the higher value alternative uses for the space (such as residential).

Multi-let units have become relatively closer to the centres of economic activity as that activity has grown around them. This has crowded out more price-sensitive occupiers and thus increased the average rent more quickly.

Source: Gerald Eve

3

Yorks/Humber

2017

North East

2016

West Midlands

2015

Scotland

2014

North West

2013

South West

2012

East of England

2011

South East

2010

Greater London

2009

UK

2008

Inner London

2

6.0

26

£9.81

10

8.0

12

15

Income: rents

OMRV and the regional decoupling of rents

OMRV growth by main business activities, 2012-17

Source: Gerald Eve

Source: Gerald Eve

£ per sq ft

%

16

50 45

14

40 35

12 112% premium

10

15

81% premium

6

25 20

95% premium

8

30

10 5

4

0 2008

2010

2012

2014

2016

2018

2020

2022

Quasi-office /archiving

Retail-related and logistics

Manufacturing

Other

Services

London and the South East Rest of UK

The chart below shows the OMRV rents for broad multi-let industrial business activities over the past 10 years. Since 2011 the spread between the main groups has widened.

OMRV by main business activities Source: Gerald Eve

The ordering below may be surprising. However, the high level of fit-out of food manufacturing occupiers means that they are likely to seek longer rent free periods, with the potential to push out headline rents to compensate. Food manufacturers, particularly ‘just-in-time’ operators also need to be close to the London population. On lease renewal, there is also greater dilapidations liability to be factored into negotiations.

£ per sq ft 12

OMRV by business activity Source: Gerald Eve £ per sq ft 12

10

11 10 8 9 8 6

7 2008

2009

2010

2011

2012

2013

2014

2015

2016

2017 6

All business sectors

Individuals

Off-site services

On-site servicing

General manufacturing

Leisure

Retail & business storage

High tech engineering

Trade counters/wholesalers

It is worth noting that manufacturing OMRV growth is as strong as it is owing to growth in food manufacturing in Inner London. Indeed, when we break down the 2017 OMRVs by specific activity, it is the food manufacturers that are at the top.

Logistics

The higher value quasi-office and retail-related tenants have occupied space that has increased in value more rapidly than the more traditional manufacturing and services space that dominated multi-let industrial in the past.

5 Quasi-office/archiving

Quasi-office/archiving Retail-related and logistics

Food manufacturing

Services Manufacturing

Another explanation for the above is that, although weighted averages, these figures do not account for where in the country these units and tenants are situated, along with a whole host of other factors that will affect the OMRV. We know, for example, that there is a high concentration of food manufacturers and quasi office/archive tenants in Inner London, which will inflate their OMRVs considerably.

27

Multi-let: Summer 2018

INCOME: RENTS WHAT IMPACT DOES AN OCCUPIER’S BUSINESS ACTIVITY HAVE ON OMRV?

WHAT IMPACT DOES AN ESTATE’S OCCUPIER BASE HAVE ON OMRV?

Using econometrics we can separate out geographical valuation differences, along with other factors such as the size of units and estates, length of income, the vacancy rate of a given estate and how diverse the business mix on it is. This way we can ascertain what the different OMRV values are for different occupiers, no matter where they are located and under what circumstances.

These results show a slightly different picture.

Using the same econometric method, we can establish if there is a statistically significant change to OMRV depending on how dominant one business activity is on an estate, all other things being equal.

Relative impact on OMRV by business activity, holding all other factors constant

Those estates with a dominant single occupier type are valued on average with an extra 68p per sq ft. Even a 30% major agglomeration of business activities on one site is statistically associated with an extra 31p per sq ft across the estate.

This is likely to be a result of two different factors:

Source: Gerald Eve

— One business type is likely to agglomerate where the conditions of an estate are generally advantageous for that type of business (i.e. links to transport or road frontage).

This will drive value for that particular estate;

OMRV, relative £ per sq ft 0.6 0.4

— The clustering itself can drive collective value if, for example, an estate establishes itself with a range of trade counter occupiers that provides a one-stop location for tradespeople.

0.2 0 -0.2

Marginal impact by dominance of business activity on the estate: OMRV

-0.4 -0.6

Source: Gerald Eve

-0.8

OMRV, additional £ per sq ft

-1.0

0.8

Individuals

Leisure

General manufacturing

On-site servicing

Off-site servicing

Food manufacturing

Retail & business storage

Trade counters/wholesalers

Quasi-office/Archiving

High tech engineering

Logistics

-1.2

Here we see that food manufacturers actually have relatively average rents. However logistics operators, high tech engineers and quasi-office/archiving tenants tend to locate in the most expensive space, paying over 40p per sq ft more than average, all other things being equal. This is likely to reflect, amongst other things, the best local positions to access homes and businesses – either as a source or destination of goods or to recruit the most appropriately skilled workforce in the case of high tech engineering.

The more traditional users of multi-let industrial space, i.e. manufacturers and on and off-site service providers, tend to occupy the poorer quality and lower valued space. Leisure and particularly individual trader occupiers operating on tighter margins and more arguably less secure business models are situated in the most heavily discounted units.

28

0.7 0.6 0.5 Dominant Additional 68p

0.4 0.3 0.2

Major Additional 31p

0.1 0

Dominant business sector (75%+ of estate floorspace) Major business sector (30%+ of estate floorspace)

Income: rents

Occupier 'clustering' has a surprisingly significant effect on the rental profile.

Marginal impact by dominance and diversity of business activity on the estate: passing rent Source: Gerald Eve Passing rent, additional ÂŁ per sq ft 0.6 0.5 0.4 Dominant Additional 52p

0.3 0.2

Major Additional 27p

In practice and in actual passing rent terms, this translates to an extra 27p per sq ft if one business activity has a major agglomeration on an estate, which rises to 52p per sq ft if that agglomeration is dominant.

0.1 0 -0.1 -0.2

Diverse Less 16p

A further impact on passing rent that does not show up as statistically significant at the valuations level is whether an estate is relatively diverse with its occupier activities. In passing rent terms this is associated with 16p less per sq ft, presumably for the reverse of the reasons why the agglomeration is beneficial.

Dominant business sector (75%+ of estate floorspace) Major business sector (30%+ of estate floorspace) Greater than 5 business sectors

Those estates with a dominant single occupier type are valued on average with an extra 68p per sq ft. Even a 30% major agglomeration of business activities on one site is statistically associated with an extra 31p per sq ft across the estate.

VALUATIONS TRANSLATING INTO INCOME We see now how valuations translate to actual contracted and passing rent for multi-let industrial in practice. During the period of rising rent over 2011-17, OMRV increased more quickly than passing rent and the reversionary potential increased. The reversionary potential is measured below as the difference between the passing rent and the OMRV, expressed as a proportion of the OMRV. This suggests that, although rental values in the market were growing strongly, a decreasing proportion of potential income was received in passing cashflow to landlords.

However, this broad picture hides a lot of current dynamics detail since, market-wide, many leases will have been signed at different points historically. Some lettings will have a contracted rent that is out of step with current rising valuations (depending on the frequency of rent reviews) and therefore be underrented. The passing rent is also likely to have been subject to various upfront concessions such as rent frees and stepped rents that will have been wound down over the life of the contract.

OMRV, passing rent and reversionary potential Source: Gerald Eve ÂŁ per sq ft

%

10.0

18

9.5

16 14

9.0

12

8.5

10 8.0 8 7.5

6

7.0

4

6.5

2 0

6.0 2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

UK multi-let industrial reversionary potential (RHS) UK multi-let industrial passing rent (LHS) UK multi-let industrial OMRV (LHS)

29

Multi-let: Summer 2018

INCOME: INCENTIVES The charts below show what proportion of the market has a rental incentive and how big that incentive is. Incentives are measured as the difference between the passing and contracted rent for units at the year-end. The different colour bands indicate lighter or heavier discounts or rent frees.

Incentives: newly-signed leases

Incentives: prevailing leases

Source: Gerald Eve

Source: Gerald Eve

% of tenancies

% of tenancies 20

60

18 50

16 14

40

12 30

10 8

20

6 4

10

2 0

0 2013

2014

5-10% discount 10-30% discount 30%-50% discount

2015

2016

2017

Over 50% discount Rent frees

2013 5-10% discount 10-30% discount 30%-50% discount

2014

2015

2016

2017

Over 50% discount Rent frees

The use of rent frees ticked up in 2017 but heavily discounted passing rents of 50% or more fell.

Here we see on the left hand side that for newly-signed leases, the proportion of tenancies with incentives in place at the end of each signing year fell in 2016 and again in 2017 to below 50% of instances. The use of rent frees ticked up in 2017 but heavily discounted passing rents of 50% or more fell.

The chart on the right hand side shows the prevailing proportion of tenancies with incentives across the market at any one time.

This is much lower than for newly-signed leases of course, and fell to around 13% of the market in 2017, with only 3.5% of all units recording zero passing rent at year-end 2017.

These bands of incentives give some more detail but do not quantify whether landlords are, on aggregate, giving away more or less potential income in incentives. For that measure we need to track the total aggregate valuation income of let units in the market, the total aggregate contracted income of those units, and the total aggregate passing rent in the market. There we find the absolute value of under or overrentedness and of incentives without needing to go into the myriad ways in which they can be expressed.

30

Income: incentives

Average months rent free on a 5 year lease Source: Gerald Eve Months

Average rent free periods have dropped from 7 months to 4 months and rents have grown by 32% over the last 5 years.

7.5 7.0 6.5 6.0 5.5 5.0 4.5 4.0 3.5 2013

Below we track the passing rent discount to contracted rent at various annual intervals. Each starts when the year new contracts are signed and follows those same units over time.

Value of incentives and how they are realised over time Source: Gerald Eve % of contracted rent

2014

2015

2016

2017

This downward trend suggests that the total value of incentives offered market-wide by landlords has fallen significantly from more than seven months rent free in 2013 to just over four months in 2017.

Landlords are converting more of the income on new contracts into actual passing rent than they were previously. But are those contracted rents keeping pace with rising OMRVs in the market?

We consider over or underrentedness by comparing OMRVs and contracted rents in the year of signing. The chart below shows that no particular trend is apparent but that new rents have, on aggregate, been below the market rate for the last three years.

45 40 35 30

Overrentedness of contracted rent to OMRV

25

Source: Gerald Eve

20

%

15

-4

10

-3

5

-2

0 Year1 2013 lettings 2014 lettings 2015 lettings

Year 2

Year 3

Year 4

Year 5

2016 lettings 2017 lettings

-1 0 1 2

The pattern is very similar for lettings starting in various years.

Contracts start with a large upfront concession that is quickly reduced by year 2 and then more gradually realised over subsequent years. This most likely reflects rent frees typically in year 1, followed by stepped rents in some instances.

We can use this information to more simply represent the use of incentives in the market, expressing them solely as the number of rent free months on a hypothetical five year contract. This gives the following time trend.

3 4 2013 lettings

2014 lettings

2015 lettings

2016 lettings

2017 lettings

In a rising market landlords may be increasingly confident to set the terms of an agreement at or above the OMRV, but valuations can still rise by the year-end to give the appearance of underrentedness.

31

Multi-let: Summer 2018

INCOME: INCENTIVES HOW THE TENANCY TERM AFFECTS THE LEVEL OF INCENTIVES Contracted and passing rent relative to OMRV: Up to 6 years to first break

Contracted and passing rent relative to OMRV: More than 6 years to first break

Source: Gerald Eve

Source: Gerald Eve

%

%

100 90 80 70

100 20%

21%

80

9%

60 40%

60%

40

30

30

10

61%

4%

50

40

20

39%

70

60 50

9%

90

31%

20

32% 19%

0

10

30%

32%

0 Passing Rent Rent free Greater than OMRV

Contract Rent

Rack rented Less than OMRV

Breaking the market down both to consider shorter term lettings of up to 6 years until the first break and longer term lettings of all those greater than 6 years, we quantify how those leases are structured differently – i.e. how longer contracts tend to be rewarded with rent discounts.

The two charts above each show contracted income on the right and passing income on the left. The stacked columns are comparisons to the OMRV for those contracts signed in 2017. If the contracted rent was 100% highlighted as rack-rented, for example, there would be no evidence of over or underrentedness in the market. If the profile of the passing rent was equal to the contracted rent there would be no evidence of incentives being used in the market.

The contracted rent on the right hand side of both charts is rackrented (equal to OMRV) for approximately 60% of all new lettings.

Passing Rent Rent free Greater than OMRV

Contract Rent

Rack rented Less than OMRV

However the leases longer than 6 years have a higher incidence of underrentedness compared to the shorter contracts (30% versus 19%). This makes sense since the contracted rent is more frequently discounted for tenants committing to a longer uninterrupted income stream. New contracts of less than 6 years were overrented for 21% of cases, but for those longer than 6 years this falls to only 9%.

The measure of passing rent on the left hand side of each chart shows that 20% of new lettings in 2017 were on a rent free at the year-end if they had less than 6 years to the first break. This almost doubles to 39% for those leases longer than 6 years, given the longer period the incentives can effectively be spread over. The group of longer leases also has a much smaller proportion of the passing rent rack-rented or overrented at the end of the signing year.

20% of new leases agreed in 2017 granted for 6 years or less benefitted from a rent free. For those longer than 6 years, the number increased to 39% of new leases.

32

Income: incentives

HOW ARE DIFFERENT OCCUPIERS INCENTIVISED?

Overrentedness of contracted rent to OMRV Source: Gerald Eve

We know from previous analysis that logistics operators tend to occupy the most expensive space. This is also true of high tech engineering and quasi-office space – the latter occupying a relatively large amount of Inner London units along with food manufacturers. These newer, cleaner and more profitable tenants tend to occupy units that are growing in value more quickly than their more traditional, dirtier and more “industrial� multi-let occupier counterparts. However, what really matters from a landlord perspective is how much of this potential income is ultimately realised as passing rent.

Looking at incentives for the main occupier groups we can see that between 2014 and 2017 discounts fell sharply for manufacturing and services type occupiers, but remained relatively constant for retail and logistics-related occupiers, which were the most heavily incentivised main group in 2017.

% 4 3 2 1 0 -1 -2 -3 -4 Retail and logistics

Manufacturing

Services

In actual fact, the same kinds of differences between the groups are maintained. Retail and logistics occupiers were not only incentivised more highly but also underrented more heavily. Conversely services occupiers had the smallest level of inducements and were actually overrented, on average, by nearly 3%.

Months rent free on a five year lease Source: Gerald Eve Months free 10 9 8

Retail-related and logistics occupiers were not only incentivised more highly but also underrented more heavily.

7 6 5 4 3 2 2014 Manufacturing Retail & logistics

2015

2016

2017

Services

The market was getting stronger and landlords clearly needed to give away far fewer inducements to let space, yet they remained elevated for retail and logistics occupiers.

Incentives only compare the contracted and passing rent, so potentially these business sector differences were offset by differences in over or underrentedness, i.e. comparing the contracted rent with the OMRV. The time series is volatile so the chart overleaf shows the 3-year average level of overrentedness for the main occupier groups.

33

Multi-let: Summer 2018

INCOME: INCENTIVES AND UNDERRENTEDNESS The following quadrant diagram breaks this down further into individual occupier activities. Those towards the top are the most incentivised, those on the right hand side are increasingly underrented, and those on the left hand side are increasingly overrented.

Logistics operators stand out as being both by far the most underrented but also the most incentivised tenants. Food manufacturers and Trade counters/wholesalers also feature on the top right quadrant. The diagonal from bottom left to top right effectively reflects a revealed preference continuum for landlords, with logistics at the top and on-site services and (particularly) individuals at the bottom.

3-year average incentives by occupier activity against 3-year average margin of under or overrentedness Source: Gerald Eve

Greater incentives

Leisure

Overrented

Logistics

Food manufacturing

Trade counters

Off-site services

General manufacturing

Underrented

Quasi-office/archiving Retail storage

High tech engineering

Individuals

Fewer incentives

On-site services

The covenant strength and brand power of some occupiers (particularly logistics) has a ripple effect on the perception of the estate, its valuation and future occupier attraction which might outweigh the cost of offering cheaper rents or more incentives.

34

Income: incentives and underrentedness

HOW ARE INCENTIVES DISTRIBUTED OVER TIME? When further considering how these incentives are distributed over time, it appears that retail-related and logistics occupiers get a relatively large proportion of their discount in the first year, whereas manufacturing occupiers and, to an even larger extent, services occupiers have their incentive spread out more over subsequent years.

Interestingly, there is geographic element to this too. Almost two-thirds of new logistics lettings in London in 2017 were still on a rent free by the year-end. This is significantly higher than in the South East and, particularly, the rest of the UK where only 6.8% of lettings are still on a rent free at this time.

How incentives are distributed over time, by main business activity

Proportion of new logistics contracts in 2017 with no rent passing at the year-end

Source: Gerald Eve

Source: Gerald Eve

%

%

90

70

80

60

70 50

60 50

40

40

30

30

20

20 10

10 0

0 Year1

Year 2

Manufacturing Retail & logistics

Year 3

Year 4

Year 5

London

South East

Rest of UK

Services

The trend for retail-related and logistics is clearly driven by logistics, which, not only being the most incentivised segment, also has an unusually large proportion of that incentive frontloaded in the first year.

How incentives are distributed over time – logistics occupiers Source: Gerald Eve

Almost two-thirds of new logistics lettings in London in 2017 were still on a rent free by the year-end.

% 100 90 80 70 60 50 40 30 20 10 0 Year1

Year 2

Year 3

Year 4

Year 5

This finding is surprising, especially considering that logistics leases tend to be shorter than for other tenants and they would not typically need a heavy fit-out.

35

Multi-let: Summer 2018

INCOME: LOGISTICS WHY DO LOGISTICS OCCUPIERS GET SUCH A RELATIVELY LARGE DISCOUNT?

Footprint and building size Logistics operators typically take much larger amounts of space than other occupier types so this could, in part, reflect a discount for quantum. However, that arguably should also have been covered in the calculation of the OMRV. Capital expenditure The data include renewals as well as completely new lettings. Thus, manufacturing or servicing type tenants that have expended more capital on a given unit are likely to be offered relatively less attractive terms to renew since they are already heavily committed to the site.

Relocation cost By that same token, logistics operators tend to be more footloose, with a more “vanilla� fit-out, which affords them the platform to drive a better deal package.

Education and representation Logistics companies tend to be larger and better represented, and thus able to conduct portfolio deals over multiple sites with the same landlords to push for economies of scale and the very best deals.

Landlord value Logistics is one of the very visible growth segments of multi-let industrial and a major part of its transition into a more desirable investment class. Recent strong investment returns have been driven by yield impact rather than income return. Getting a well-known international brand into a portfolio, potentially in place of an equally profitable local firm, is clearly desirable at both the investor and fund manager level to make the overall investment more attractive and potentially sharpen the yield. Thus, the extra discounts to the passing rent to secure such tenants makes economic sense. Moreover, valuers are not totally immune from brand power either and this could arguably also have an influence on the higher OMRVs recorded for space let to logistics firms.

Having big name occupiers can, after all, lift the profile of an estate.

UK multi-let industrial property has had to adapt to the changing way we live and shop. As more goods are bought online, a new industrial asset class has emerged to service this activity.

36

Income: logistics

Logistics occupiers, especially in London, tend to be higher-value well-represented ‘corporate’ tenants who occupy larger units and have a lower-than-average default rate. They are, however, more likely to exercise a break and vacate on expiry of a lease. They use their brand power and the fact that they occupy the largest, most expensive space, to leverage the best initial deal package.

37

Multi-let: Summer 2018

INCOME SUMMARY • Multi-let industrial rents across the UK increased by almost a third in the past five years, taking the average OMRV to £9.81 per sq ft in 2017. Not only are London and the South East more expensive than the rest of the UK, but rents have been growing more strongly there, and this is set to continue.

• Quasi-office and retail-related and logistics tenants occupy more expensive space, which has also increased in value more rapidly than the more traditional manufacturing and services space that dominated multi-let industrial in the past.

• Those estates with a dominant single occupier type record an extra 52p per sq ft passing rent. Even a 30% major agglomeration of business activities on one site is linked to an extra 27p per sq ft.

Conversely, diverse estates with five or more different business activities achieve 16p per sq ft less.

• The total value of incentives offered on new leases fell significantly over 2013-17 from more than seven months rent free on a hypothetical five-year lease contract to just over four months. Despite this, the reversionary potential across the whole market increased as rental values rose sharply.

• Incentives fell for manufacturing and services type occupiers over the period, leaving retail-related and logistics occupiers the most heavily incentivised and underrented main group in 2017.

• As a subset, logistics operators not only have far more discounts than other occupiers, but also the most front-loaded discounts, particularly in London. At first this seems counter intuitive since logistics occupiers tend to take the best quality space and would not typically need rent frees in lieu of the cost of fit out.

• However, (inter)national logistics firms are the face of the transforming multi-let industrial sector. They have recognisable brand power that has a value to fund managers, investors and valuers, and arguably adds to the bottom line in a portfolio. Consequently it can make economic sense to offer discounts to ensure these occupiers are on the rent roll.

38

LENGTH OF INCOME KEY QUESTIONS • What is the average length of lease agreed on multi-let industrial units?

• How has this changed over the last 10 years?

• What is the average time to first lease break on newly signed lease and how has this changed?

• Do certain occupier sectors offer longer income and why?

39

Multi-let: Summer 2018

LENGTH OF INCOME Newly-signed lease length and time to first break (weighted by OMRV) Source: Gerald Eve Years 8.0

7.5

7.5 yrs 7.0

6.5

6.0

5.5

5.5 yrs 5.0

4.5

4.0 2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Time to first break Lease length

The lease length and time to first break on newly-signed leases has been trending upwards since 2010 and at end-2017 reached 7.5 years and 5.5 years, respectively. This is consistent with an occupier base growing in business confidence and financial stability.

Time to first break, newly-signed leases in 2017 (weighted

by OMRV) Source: Gerald Eve % of market 25

Splitting out the 2017 average weighted time to first break into duration strata shows that almost half of all leases had a break in income after 4-10 years, either through an actual break or an expiry. Around 11% of leases had a break up to only one year into the tenancy.

20

15

10

40

5

over 15 years

11-15 years

6-10 years

4-5 years

2-3 years

0 Up to a year

The lease length and time to first break on newly-signed leases has been trending upwards since 2010.

Length of income

Income length: by business activity

Income length: by region

Source: Gerald Eve

Source: Gerald Eve

Years

Sorting the data into occupier activities and UK regions we can see that individuals are noticeably associated with a much shorter length of income. In terms of geographical regions, those with particularly short income include Yorks/Humber, Wales and the North East. These regions are associated with some of the smallest individual unit sizes and more diverse estates, which ties in with a more transitory occupier market.

Since various factors can skew the figures for occupier activity, such as where in the country units are located and the conditions on an estate, we can again use econometrics to isolate the length of time to the first break for the different types of occupier. All other things being equal, logistics operators tend to have the shortest period until the first break. This kind of tenant flexibility built into the lease is likely linked to their bargaining power and since logistics activities tend to be connected to a fixed-length business contract with a third party.

South East

East of England

Inner London

Greater London

West Midlands

South West

North West

All regions

Time to first break Lease length

Scotland

2 North East

2

Wales

3

High tech engineering

3

Trade counters/wholesalers

4

Quasi-office/archiving

4

Retail and business storage

5

Off-site services

5

Leisure

6

Food manufacturing

6

General manufacturing

7

Logistics

7

On-site servicing

8

Individuals

8

All business activities

9

Yorks/Humber

Years

9

Time to first break Lease length

At the other end of the scale are the trade counters/wholesalers, which tend to invest in an area to build up regular custom and are thus more committed to a longer tenancy. This is also potentially a factor for the on-site serving occupiers, which create ‘good will’ from a particular location. Food manufacturers also feature at the higher end, in part related to the larger capital expenditure required on any given unit and the need to spread that cost over a longer time period.

Relative differences of time to first break by business activity, all else being equal Source: Gerald Eve Relative months, time to first break 8 6 4 2

-4 -6 -8

Logistics

High tech engineering

General manufacturing

Retail and business storage

Leisure

Off-site services

Individuals

Quasi office/archiving

On-site servicing

-10 Food manufacturing

Individuals have considerably less of a time discount on this measure than the standard weighted average, which arguably reveals their relatively weaker bargaining position, despite the increased need for flexibility.

0 -2

Trade counters/wholesalers

A surprising result is that the high tech engineering occupiers have relatively short income once other factors are stripped out since fit out costs are relatively high. This could potentially be because high tech engineers occupying multi-let industrial space are more likely to be the smaller, start up type firms that need increased flexibility if growing rapidly.

41

Multi-let: Summer 2018

LENGTH OF INCOME SUMMARY • The lease length and time to first break on newly-signed leases has been trending upwards since 2010 and at end-2017 reached 7.5 years and 5.5 years, respectively. • Logistics operators tend to have the shortest period until the first break, in part since logistics activities tend to be connected to a fixed-length business contract with a third party. • Trade counters/wholesalers have the longest period to first break, given capital expenditure and the commitment to an area to build up goodwill and custom. Food manufacturers also feature at the higher end, in part related to the larger capital expenditure required on any given unit.

42

SECURITY OF INCOME KEY QUESTIONS • What is the average void rate of multi-let industrial properties?

• How has this changed over the last 10 years?

• Are there any regional differences in void rates and why?

• What is the tenant ‘churn’ rate of multi-let industrial?

• What is the tenant retention rate of multi-let industrial and does this change by occupier sector?

• What is the propensity to exercise a break clause and does this change by occupier sector?

• What happens on lease expiry?

• What is the tenant ‘default’ rate of multi-let industrial property?

43

Multi-let: Summer 2018

SECURITY OF INCOME: VOID RATES UK regional void rates by major region (% of floorspace) Source: Gerald Eve % 19

Average void period for any individual unit

17 15 13 11

10.4 months

9 7 5 3 2009

All UK London

2010

2011

2012

2013

2014

2015

2016

2017

South East Rest of UK

VOIDS HAVE FALLEN SHARPLY So far we’ve discussed how and why actual income received can fall short of the potential valuation amount on let properties.

However, when an multi-let industrial unit is not let and therefore void, the opportunity cost is absolute. So what proportion of the UK multi-let industrial market has been vacant and not producing any income over the recent past?

average void rate vary significantly in size, with the more prosperous and active Greater London area many multiples bigger in multilet industrial floorspace terms than, say, Wales or the North East.

These smaller areas in institutional portfolios arguably have a higher concentration of the very best stock in the region in this dataset and thus have a lower void rate than might otherwise be expected.

The change over time has been significant. As a proportion of floorspace, the UK average void rate was hovering around the high teens for a number of years until 2012. Then it fell sharply to finish five years later at only 6.7%. This ties in with other property metrics over the period showing positive improvement, such as increased rents and a drop in incentives. This also sits alongside the most active phase of transforming the tenant base towards higher-value retail and logistics and quasi-office occupiers.

2017 void rates: by region

44

10 8

6.7%

6 4 2

UK

Inner London

South West

South East

North East

Scotland

North West

Wales

Greater London

Yorks/Humber

0 East of England

The regions with the highest void rate in 2017 were the West Midlands, the East of England and Yorks/Humber – regions with arguably a more diverse quality of units that can make their way into institutional portfolios. The mid group of regions around the national

% 12

West MIdlands

The stronger performing regions with higher exposure to the transforming occupier base – i.e. London and the South East – generally have a lower void rate than the rest of the UK. As London and the South East are to some extent substitute markets for each other we can see how the rapid decline in the London void rate over 2013-15 was subsequently matched by an equally sharp fall in the South East in 2017.

Source: Gerald Eve

Security of income: void rates

2017 void rates: by unit size

2017 void rates: by estate size

Source: Gerald Eve

Source: Gerald Eve

%

% 12

10

10 8

8

6 4

6

2

All

Over 250,000 sq ft

100,000-250,000 sq ft

50,000-100,000 sq ft

25,000 - 50,000 sq ft

Below 25,000 sq ft

All

25,000 - 50,000 sq ft

10,000 - 25,000 sq ft

5,000 - 10,000 sq ft

2,500 - 5,000 sq ft

1,000 - 2,500 sq ft

0 Below 1,000 sq ft

4

2017 void rates: by number of units on an estate

2017 void rates: by diversity of occupier sectors on an estate

Source: Gerald Eve

Source: Gerald Eve %

% 14

9 8

12

7 10

6

8

5

6

4 3

4

2 2

1

0 All

81-140 units

41-80 units

21-40 units

11-20 units

6-10 units

2-5 units

0

In terms of size of individual units and estates, the data suggest that it is those very small units under 1,000 sq ft on the biggest estates that experience the highest void rates.

These smaller units tend to be associated with a higher incidence of tenant failure, plus a small unit on a larger estate is arguably under less scrutiny by the management of the estate.

Five or more different business activities

Fewer than five different business activities

This is also played out in terms of the number of units on an estate and the diversity of business activities on estates. A greater number of individual units and a more diverse range of activities are typically associated with higher void rates. Generally speaking, bigger units, with fewer neighbouring units and lower congestion of competing industries means a more desirable space for occupiers and better control for landlords and thus lower void rates.

45

Multi-let: Summer 2018

SECURITY OF INCOME: TENANT CHURN Proportion of tenant churn by event type Source: Gerald Eve % 20 18 16 14 12 10 8 6 4 2

4.9%

3.8%

3.2%

3.2%

2015

2016

2017

0 2014 Let unit becomes vacant Vacant unit becomes let

Change of tenant

A healthy market needs some element of “churn” to help it function. However this can be disruptive for occupiers and landlord administration and cashflow. The multi-let market has become more stable over the past four years and incidences of this churn – a switch between a let or vacant space or a change in the tenant in a unit – decreased from nearly 20% in 2014 to just over 14% in 2017.

There were two major driving factors behind this. Firstly, the proportion of occupiers retained from one year to the next increased over the period from 77% to almost 84%. Secondly, the proportion of units that became newly vacant each year fell from 4.9% to 3.2%. These factors reflect increased occupier confidence and demand, along with the increasing lease lengths described in the previous section.

84% Proportion of tenants retained from the previous year Proportion of tenants retained from the previous year Source: Gerald Eve % 84

The multi-let market has become more stable over the past 4 years.

83 82 81 80 79 78 77 76 2014

46

2015

2016

2017

Security of income: tenant churn

Which types of occupiers does this apply to? Unsurprisingly, given the earlier analysis of the transition of the occupier base, it is the retail-related and logistics occupiers that are increasingly supporting this trend.

The charts below show the contribution to retained tenants each year split by different business activities. Manufacturing occupiers and those that provide services both on and off-site, are responsible for providing fewer retained occupiers each year.

Contribution to retained tenant: by business activity

Contribution to retained tenant: by business activity

Source: Gerald Eve

Source: Gerald Eve

%

%

50

16 15

45

14 13

40

12 35

11 10

30

9 25

8 2014

2015

2016

2017

2014

Retail-related and logistics Manufacturing

2015

2016

2017

Quasi-office/archiving Services

On the flip side, we consider those units that have become vacant each year and the proportion of business sectors that previously occupied them.

Here we see that, while retail-related and logistics-type occupiers account for more of these new voids than manufacturing ones (given their larger share of the market) the retail-related and logistics trend is downwards. Manufacturing, however, is the only major segment that is increasingly responsible for the returned vacated space.

Proportion of newly vacant space: by former occupier main business activity

Proportion of newly vacant space: by former occupier main business activity

Source: Gerald Eve

Source: Gerald Eve

%

%

45

21 19

40 17 35

15 13

30

11 25 9 20

7 2014 Retail-related & logistics General manufacturing

2015

2016

2017

2014

2015

2016

2017

Services Quasi-office/archiving

47

Multi-let Industrial Summer 2018

SECURITY OF INCOME: TENANT CHURN Taking this a stage further and breaking it down into some of the separate business activity groups we see that individuals and general manufacturers are responsible for an increasing share of newly vacant space, whereas the share for logistics operators

has fallen significantly. The trend for trade counters/wholesalers is less obvious, but its proportion of newly vacant space is below its share of the market as a whole, which was 24% in 2017.

Proportion of newly vacant space by former occupier individual business activity Source: Gerald Eve

Individuals 5

Logistics

%

18

4

16

3

14

2

12

1

10

0

8 2014

2015

2016

2017

General manufacturing 25

2014

2015

2016

2017

2016

2017

Trade counters/wholesalers

%

21

20

17

15

13

10

9

5

%

5 2014

48

%

2015

2016

2017

2014

2015

Security of Income

49

Multi-let: Summer 2018

SECURITY OF INCOME: BREAKS, EXPIRIES AND DEFAULTS LEASE BREAKS Another factor affecting churn in the market is if a tenant exercises a break clause. Around half of all new contracts had a break clause included in them in 2017, with a greater proportion among the longer leases of over six years and a smaller proportion among leases of six years or less.

Proportion of new contracts in 2017 with a break clause

But where a break is exercised, what happens next? We can see that, although in very recent years the propensity to break has increased slightly, increased occupier demand means that this has been matched with a higher proportion of breaks re-let to a new tenant within the year. Thus, the amount of new vacancy as a result of an exercised break has remained broadly constant over this period.

Source: Gerald Eve

What happens at a break event?

%

Source: Gerald Eve

70

%

60

100 90

50

80 40

70 60

30

50

20

40

10

30 20

0 Up to 6 years contract

Over 6 years contract

10

All new contracts

0 2010

A very small amount of units actually have a break event in any one year. By count of tenancies, it was around 4.9% in 2017 and by OMRV it was even less, at 1.9% of all units. Consequently we have to be careful with drawing any conclusions from these statistics and be aware that there will be some significant volatility.

The data suggest that the propensity to exercise a break has fallen significantly since 2011, where a large majority were exercised.

The propensity to break was 36% in 2017, which is a slight tick up from the low point of 24% in 2014.

2011

2012

2013

2014

2015

2016

2017

2016

2017

Not exercised Exercised: new vacancy at year end Exercised: re-let at year end

What happens following an exercised break?

Source: Gerald Eve % 100 90 80

Propensity to exercise break

70

Source: Gerald Eve

60

%

50

80

40

70

30 20

60

10 50

0 2010

40

Exercised: re-let Exercised: vacancy

30 20 10 2010

50

2011

2011

2012

2013

2014

2015

2016

2017

2012

2013

2014

2015

Security of income: breaks, expiries and defaults

Although in recent years the propensity to exercise a break has increased slightly, this has been more than matched in an increase in space being re-let to a new tenant.

Since the sample size is very small, if we want to separate break events data further into different business activities we need to group together data over the past four years.

Retail & business storage has the lowest propensity to break, presumably because these units are servicing separate stores or business operations that tend to operate over a relatively long business timeframe. High tech engineering occupiers would also be expected to have a low propensity to break since they typically spend a relatively large amount on fit-out and have more stringent requirements in terms of access to a skilled workforce or licences.

The service providers and trade counters/wholesalers have the local goodwill factor to also keep them more often in place.

Individuals are more likely than any other business activity to exercise a break, occurring at almost two thirds of break dates.

This fits with the character of this more volatile and transitory segment. Logistics operators and office archiving can afford to be more footloose in terms of where precisely they situate themselves and spend less on the fit-out so the propensity is relatively high also. The surprisingly high propensity to come out of these data is that of food manufacturers. These occupiers spend a relatively high amount on fit-out, similar to the high tech engineers.

One reason could be that, with relatively long leases, these exercised breaks could be after a longer period than the other sectors. Again, the sample size is small for this area and volatility is high, so it is one for us to monitor for the future.

Propensity to exercise break, 4-year average by business activity Source: Gerald Eve % 70

60

50

40

30

20

10

All business sectors

Individuals

Quasi office/archiving

Food manufacturing

General manuacturing

Logistics

Leisure

Trade counters/wholesalers

Off-site servicing

On-site servicing

High tech engineering

Retail & business storage

0

51

Multi-let: Summer 2018

SECURITY OF INCOME: BREAKS, EXPIRIES AND DEFAULTS LEASE EXPIRIES Some leases have break clauses but all leases ultimately have an expiry. In recent years the average proportion of leases that reach expiry in any one year was 10.5%.

The proportion of lease expiries where the tenant was retained the subsequent year has been trending very steadily upwards since 2009. Tenants were retained in around two thirds of cases in 2017, almost double that of eight years earlier.

In terms of business activity, the relatively high cost fit-out occupiers such as the high tech engineers and food manufacturers had the highest rates of retention. Other tenants that will have invested in local goodwill, such as trade counters/wholesalers and the service providers are also relatively ‘sticky’ on expiry.

At the lower end of the scale are the occupiers with more straightforward fit-outs for storage-type purposes. Logistics operators have a particularly low retention rate post-expiry, in part because typically a leasing contract is aligned to the business contract they have to provide services to a third party.

Similar to the other metrics, as the occupier environment has improved the proportion of expiries that led to a vacant unit fell from almost a quarter of all cases in 2012 to just over 11% in 2017.

Proportion of expiries that retain the tenant by business activity (4 year average) Source: Gerald Eve % 90

Proportion of expiries that retain the tenant

80

Source: Gerald Eve

Relatively less expensive move costs

70

%

60

70

50

65

40

60

30 55

20

50

10

45

2013

2014

2015

2016

2017

Proportion of expiries that lead to a vacant unit

What happens on expiry: 2017

Source: Gerald Eve

Source: Gerald Eve %

% 100

25

90 80

22

70

Retain tenant 66.7%

60

19

50 40

16

30 20

13

10 0

10 2009

52

2010

2011

2012

2013

2014

2015

2016

2017

Change tenant 22.2% Vacancy 11.1%

All activities

Logistics

Individuals

Off-site services

Quasi-office/archiving

2012

Retail & business storage

2011

General manufacturing

2010

On-site servicing

30

Trade counters/wholesalers

35

Leisure

40

Food manufacturing

High tech engineering

0

Security of income: breaks, expiries and defaults

LEASE DEFAULTS When considering default rates by business activity it is interesting to note that logistics operators have the lowest default rate of any other sector. This is despite the fact that they tend to have the shortest contracts and be relatively likely to vacate on a break or expiry.

The final possibility for generating churn in the market is through default. Here we have defined this as a firm occupying a unit with a contract in place committing them to be in occupation the subsequent year but is either replaced by a different firm or becomes a vacant unit in that subsequent year.

The trend over time is below. Similar to the other measures there is evidence of a sharp fall since 2011. The slight pick-up in 2017, however, is not entirely surprisingly, given the somewhat more uncertain economic environment and downward revision for GDP forecasts.

More broadly, retail-related and logistics – the main segment that has been occupying an increasing proportion of multi-let industrial floorspace – has the lowest default rate. Manufacturing and services occupiers are over a percentage point higher. Individuals have the highest chance of default, in keeping with the relatively higher company failure rate for that segment.

All UK multi-let industrial default rate and UK insolvency rate

3-year average default rate by business activity

Sources: Gerald Eve, ONS

Source: Gerald Eve

% of occupied units

%

% of active firms

9

0.9

10 9

8

0.8

7 6

0.7

8 7

Retail-related and logisitcs 2.5%

Manufacturing 3.6%

Services 3.5%

3.2%

3.7% 5.8%

6

5 0.6 4

5 4

3

0.5

2 0.4 1

3 2 1

Individuals

Quasi office/archiving

0 Leisure

Multi-let industrial default rate (LHS) Insolvencies (RHS)

2017

Off-site services

2016

On-site servicing

2015

Food manufacturing

2014

High tech engineering

2013

General manufacturing

2012

Logistics

2011

Trade counters/wholesalers

0.3

Retail & business storage

0

UK multi-let industrial default rate

3.6%

53

Multi-let: Summer 2018

SECURITY OF INCOME SUMMARY • The UK average void rate was hovering around the high teens for a number of years until 2012. Then it fell sharply to finish 2017 at only 6.7%.

• The stronger performing regions with higher exposure to the more “gentrified” occupier base – i.e. London and the South East – generally have a lower void rate than the rest of the UK. Relatively larger units on relatively smaller estates, with fewer competing business activities typically means a more desirable space for occupiers and better control for landlords – and thus lower void rates.

• The multi-let market has become more stable and “churn” decreased from nearly 20% in 2014 to just over 14% in 2017. The proportion of occupiers retained each year increased from 77% to 84%, and the proportion of newly vacant units each year fell from 4.9% to 3.2%.

• Around half of all new leases had a break clause included in them in 2017. The propensity to exercise a break has fallen significantly in the last six years to 36% in 2017.

• Following a lease expiry, tenants were retained in around two thirds of cases in 2017, almost double that of eight years earlier. The proportion of expiries that led to a vacant unit fell from almost a quarter of all cases in 2012 to just over 11% in 2017.

• The relatively high cost fit out occupiers such as the high tech engineers and food manufacturers had the highest rates of retention. Other tenants that will have invested in local goodwill, such as Trade counters/wholesalers and the service providers are also relatively ‘sticky’ on expiry.

• The default rate has trended downwards over the past eight years, with a slight pick up to 3.6% in 2017 – in line with the trend in national company insolvencies. Logistics operators have the lowest default rate of any other sector, at only 1.7%. This is despite the fact that they are much more likely to vacate on a break or expiry.

54

INVESTMENT MARKET KEY QUESTIONS • How has investor appetite for multi-let industrial changed over the last 10 years?

• Who are the most active buyers and sellers?

• How has multi-let industrial property performed against other asset classes?

• What are the reasons for this performance?

55

Multi-let: Summer 2018

INVESTMENT MARKET UK multi-let industrial, formerly the least glitzy of all property sectors, has attracted huge attention in recent years. Investor appetite shifted up several gears over 2013-17, with an annual average of £3.6bn transacted – more than double the £1.7bn annual average over 2008-12.

Multi-let industrial investment volumes by broad region 2008-2017 Sources: Gerald Eve, Property Data £ billion 5.0 4.5

Multi-let industrial investment volumes 2008-2017

4.0

Sources: Gerald Eve, Property Data

3.5

£ billion

3.0

5.0

2.5

4.5 4.0

2.0

£3.6bn

1.5

3.5

1.0

3.0

0.5

2.5

0

£1.7bn

2.0

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

1.5 Portfolio London and the South East

1.0

Rest of UK

0.5 0 2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Multi-let industrial investment volumes 5 year average

Portfolio deals have featured highly, typically accounting for around 40% of the total volume each year over the past 10 years, giving investors large scale, quick exposure into the market. Blackstone and M7 Real Estate were notable in 2017 and purchased a portfolio of industrial estates from Brockton Capital and Dunedin Properties in a £559m off-market deal.

Likewise, Ares Management bought West Midlands-based industrial developer and investor Revelan Group for £200m, giving the asset manager a foothold in the industrial sector.

Excluding portfolio purchases, transactions in London and the South East accounted for around a third of the total in 2016 and 2017. This is somewhat less than would be expected, given that the value share in our multi-let industrial dataset for London and the South East is around a half.

This arguably reflects the shortage of opportunites in London and the South East as opposed to any lack of investor appetite. There is an investment supply shortage in London, given the continued loss of land to higher value uses, such as residential. Strong occupier demand coupled with a very weak development pipeline, means rental growth forecasts continue to be bullish, and this helps amplify the attractiveness of London multi-let industrial.

Consequently it has been necessary for some investors to broaden their focus and we have seen relatively greater investment outside of the South East where investment supply is more available.

Investor appetite shifted up several gears over 2013-17, with an annual average of £3.6bn transacted – more than double the £1.7bn annual average over 2008-12.

56

Investment market

It has been necessary for some investors to broaden their focus and we have seen relatively greater investment outside of the South East where investment supply is more available.

Overseas investors were the most active purchasers in 2017 and accounted for 31% of transactions, marginally higher than UK institutions. The reduction in the pound–dollar exchange rate, meant that international investors, particularly from $US-pegged currencies saw this as a further opportunity to buy UK multi-let industrial assets at a discount.

Multi-let industrial investment volumes by purchaser type 2013-2017 Sources: Gerald Eve, Property Data

Net investment by investor type over 2013-17 Sources: Gerald Eve, Property Data ÂŁ billion 2.5 2.0 1.5 1.0 0.5 0 -0.5

% 100

-1.0

90

-1.5

80

-2.0

70

30 20 10 0 2013 Occupiers Overseas investors Private investors

2014

2015

2016

2017

UK institutions Property companies Confidential/Other

Property companies

Confidential /Other

Occupiers

40

Private Investors

Overseas Investors

50

UK institutions

-2.5

60

In contrast, property companies have been the main divestors from multi-let industrial, reducing their exposure by nearly ÂŁ2bn over 2013-17. These investors will have been profit taking after several years of capital uplift and strong investment returns arising from their own asset management initiatives and performance in the market more broadly.

UK institutions also continued to be active in 2017 and accounted for 29% of purchases. As shown in the net investment chart, institutions have significantly increased their exposure to multi-let industrial over the past five years, along with overseas investors.

57

Multi-let: Summer 2018

INVESTMENT MARKET Capital growth has been the main attraction for investors, with values having increased by an enormous 56% over 2013-17.

MSCI’s best proxy for multi-let industrial property, Standard industrial, has outperformed the other main segments for the last four years. In 2016 and 2017 the difference was dramatic, reaching over 20% total return in 2017 while the other segments were far behind in the single digits.

Total return by property sector, 2013-17 Sources: Gerald Eve, MSCI % annual total return 25

20

When we consider retail and standard industrial yields and the spread, the yield impact on multi-let industrial capital values is very apparent. The spread of the standard industrial equivalent yield over its retail counterpart has historically been on average in the several hundreds of basis points (bps). Incredibly, the spread closed to only 19.6bps in 2017 – an unprecedented figure – as standard industrial yields were aggressively bid downwards.

15

10

5

Equivalent yields and spread, 1981-2017

0

Sources: Gerald Eve, MSCI Yield, %

Capital value, 2013 base=100

150 140 130 120 110 100 90

Retail Office Standard industrial

58

4

0 2017

50

2009

100

5

2007

6

2005

150

2003

200

7

2001

8

1999

250

1997

300

9

1995

10

Yield spread (bps) (RHS) Retail (LHS) Standard industrial (LHS)

160

2014

350

1993

Sources: Gerald Eve, MSCI

2013

400

11

1981

Indexed capital values by property sector, 2013-2017

12

1991

This capital growth has been the main attraction for investors, with values having increased by an enormous 56% over 2013-17, compared to 35% for offices and only 13% for retail.

450

1989

Capital value growth was the main driver, mostly as a result of strong yield compression, but also positive rental growth.

Yield spread, bps

13

1987

Retail Office Standard industrial

2015

2017

2013

2016

2011

2015

1985

2014

1983

2013

2015

2016

2017

Our view is that average yields will see further compression through 2018 in both the South East and regions. The latter in particular will accelerate as investors seek out additional yield in regional markets and increase competition. New transactions outside the South East will provide valuation to support inward yield movement, especially in strong regional cities with high population densities benefitting from investment in infrastructure.

Interest rates seem unlikely to increase rapidly meaning the yield gap between multi-let equivialent yields and gilt rates should be sufficient for the next few years.

INVESTMENT MARKET Summary • Investor appetite shifted up several gears over 2013-17, with an annual average of £3.6bn transacted – more than double the £1.7bn annual average over 2008-12.

• Overseas investors were the most active purchasers in 2017, marginally ahead of UK institutions and on the back of the reduction in the pound–dollar exchange rate. Over the past five years overseas investors and UK institutions have increased their exposure to multi-let industrial by over £2bn and £1.5bn, respectively. Property companies were the main divestors from multi-let industrial over 2013-17, reducing their exposure by nearly £2bn.

• Multi-let industrial has drastically outperformed the main property segments in recent years, driven by yield impact and capital growth.

Multi-let industrial capital values increased by an enormous 56% over 2013-17, compared to 35% for offices and only 13% for retail.

• The yield spread of multi-let industrial over retail, historically in the hundreds of basis points, closed to only 19.6bps in 2017 – an unprecedented figure – as standard industrial yields were aggressively bid downwards.

• Multi-let industrial units have taken on more and more retail-type characteristics and drivers with the proliferation of business and consumer online activity leading to the boom in logistics operations, and an increasing share of trade counter occupiers.

• Standard industrial yields are at an all-time low. However, we think they will continue to compress through 2018 in both the South East and wider UK regions. The latter will benefit from new transactions providing evidence for valuers to move yields inwards.

Multi-let: Summer 2018

REFERENCE TABLES By occupier sector

Share of occupied floorspace (%)

Unit size (sq ft)^

OMRV (£ per sq ft)^

Relative OMRV (£ per sq ft)**

Time to first break (years)^*

Contract length (years)^*

Trade counters/wholesalers

23.3

6,444

10.36

0.23

6.2

8.1

Retail and business storage

10.8

5,349

9.37

0.19

5.7

7.5

Logistics

8.8

13,507

10.94

0.46

4.5

6.8

Food manufacturing

5.2

6,378

11.45

0.01

5.1

7.6

General manufacturing

17.2

6,899

8.86

-0.18

4.7

6.7

High tech engineering

5.4

5,428

9.81

0.43

6.6

8.0

On-site servicing

5.3

4,091

8.79

-0.09

4.3

6.1

Off-site services

6.8

4,221

8.04

-0.06

5.5

7.3

Leisure

1.9

5,188

9.02

-0.37

5.5

8.6

13.1

7,339

11.22

0.42

6.1

8.2

Individuals

2.3

2,611

6.72

-1.04

3.4

4.4

All business activities

100

6,086

9.81

-

5.5

7.5

Quasi office/archiving

^ Weighted by OMRV * Newly-signed leases in 2017 ** Relative differences, holding all other factors constant (econometrically derived) By region

Proportion of total floorspace (%)

Proportion of total OMRV (%)

Proportion of total no. of units (%)

Unit size (sq ft)*

OMRV (£ per sq ft)*

Void rate (%)**

East Midlands

3.9

2.0

4.6

5,129

4.91

n/a

East of England

7.6

6.9

5.9

7,758

8.99

9.4

Greater London

14.0

21.9

9.7

8,792

12.58

6.8

Inner London

7.7

13.7

4.5

10,329

14.52

1.8

North East

6.3

4.0

12.4

3,088

5.29

5.7

North West

8.4

5.8

11.3

4,488

6.24

6.2

Scotland

7.8

5.0

9.4

5,030

6.01

5.9

South East

19.9

24.1

12.4

9,721

10.50

4.4

South West

5.0

3.8

5.4

5,666

7.03

4.2

Wales

2.9

1.5

5.0

3,477

4.17

6.5

West Midlands

10.7

7.3

10.0

6,533

5.52

10.0

Yorks/Humber

6.0

3.9

9.3

3,944

4.93

9.3

UK

100

100

100

6,086

9.81

6.7

* Weighted by OMRV ** Proportion of floorspace

60

Reference tables

Proportion of estates with business activity specialisation and diversity (%) Dominant (75%+ floorspace)

14.3

Majority (50%+ floorspace)

36.3

Major (30%+ floorspace)

84.5

Diverse (>5 business activities)

33.4

Unit size

Void rate, 2017 (%)

Below 1,000 sq ft

9.3

1,000 - 2,500 sq ft

6.0

2,500 - 5,000 sq ft

8.0

5,000 - 10,000 sq ft

6.5

10,000 - 25,000 sq ft

6.8

25,000 - 50,000 sq ft

6.2

Estate size

Void rate, 2017 (%)

Below 25,000 sq ft

3.8

25,000 - 50,000 sq ft

4.1

50,000 - 100,000 sq ft

8.0

100,000 - 250,000 sq ft

5.2

250,000 sq ft+

Number of units on an estate

10.3

Void rate, 2017 (%)

2-5 units

7.8

6-10 units

4.3

11-20 units

4.2

21-40 units

8.3

41-81 units

13.1

81-140 units

10.0

Diversity of estate

Void rate, 2017 (%)

Five or more different business activities

8.3

Fewer than five different business activities

5.8

All

6.7

61

Multi-let: Summer 2018

GLOSSARY STUDY DEFINITIONS Multi-let industrial For the purposes of this report, multi-let industrial covers industrial units between 500 and 50,000 sq ft in size on a lease up to 30 years in length located in the UK. Multi-let industrial estate An industrial estate usually under single ownership and comprised of different sized units let to multiple occupiers.

OCCUPIERS Description

Examples

Trade counters/ wholesalers

Goods are stored and there is also some kind of on-site sales/retail function for visiting trade and/or the public.

Sellers of windows, doors, carpets, tiles, garden, tools, building supplies.

Retail & business storage

Goods or equipment are stored but solely for the purpose of onward business (such as a retail store, sold remotely to an off-site location or for carrying out business operations).

Non-public facing.

Internet retailers, department stores, utilities companies.

Includes self storage.

Logistics

Dedicated storage and distribution for a third party.

Non-public facing.

Parcel and post/3PL

Food manufacturing

Production or processing of foodstuffs for humans or animals occurs on-site.

Non-public facing.

Abattoirs, bakeries, breweries, cheese making, coffee roasting, dairies, meat/fish smoking/curing

General manufacturing

Production of relatively basic physical components or products occurs on-site.

Non-public facing.

Fabricators, moulders.

Includes waste/recycling.

High tech engineering

Complex construction/testing.

Research and development.

Non-public facing.

Incl. electronic, biomedical, nuclear, aerospace industries.

On-site servicing

Third party items are brought on-site by trade or the public for testing/repairing.

M.O.T./servicing, valeting, tyres and other vehicle/machine/ goods repair.

Off-site services

Services to business or residential offered off-site.

Potentially a public facing element/small office on-site.

Shopfitters, joiners, builders, plumbers, electricians, scaffolders, machine/car hire.

Leisure

On-site offer of leisure goods and services to the public typically fitness or play.

Gyms, sports training/ rehabilitation, soft play, trampoline warehouses.

Quasi office/ archiving

Ranges from storage of documents/data to full office or training centre functions.

Public sector bodies, data centres, designers, finance, solicitors, estate agents, employment agencies, call centres.

Individuals

Lease in the name of an individual and a company cannot be traced.

Potentially any of the above.

Multi-let industrial unit An individual industrial unit situated in an industrial estate, usually let to one tenant.

Contributor For the purposes of this report, reference to ‘contributor’ refers to the landlords or companies who have provided tenancy and valuation information which forms the basis of this study.

Regions The location of each unit in the multi-let sample is assessed by individual postcode. This report aggregates up these individual postcodes into standard UK Government Office Regions, including Scotland and Wales. “Inner London” includes only the inner London postcodes (E, EC, N, NE, NW, SE, SW, W, WC).

62

Glossary

KEY TERMS

Capital growth The annual percentage increase in value of an asset.

MSCI MSCI produce research-based indexes and analytics on the UK property market and are an independent benchmark of property investment market performance. MSCI data used in this report is the 2017 Annual Digest and reference to Standard Industrial refers to all industrials excluding distribution warehouse centres.

Churn rate Proportion of units where there is a change in occupancy between one year and the next (such as a unit let following vacancy, becoming vacant following a let, or a change of tenant). Measured as a % of OMRV.

OMRV (or ERV) Open market rental value. A valuation estimate of what could be charged if the unit were let in the open market on the valuation date. This data has been provided by the contributing investors and funds for all units within the sample.

Contracted rent The annual rent stipulated in the lease contract. This might be above or below the OMRV if it is over or underrented.

Overrented A term used to describe when the contracted rent is above the open market rental value, which implies a negative reversion.

Default rate Leases in default are calculated by assessing whether a tenant under a contractual lease obligation is no longer in occupation.

Expressed as a % of the OMRV total.

Passing rent The annual rent actually paid, which may be more or less than the OMRV and equal to or less than the contracted rent.

Capital value The market value of an asset that could be reasonably expected to be paid in an open market.

Econometrics Mathematical and statistical analysis aimed to give empirical content to economic relationships. Seeks to exclude all other factors other than the issue at hand to try to isolate and quantify relationships.

Hypothetical months rent free incentive calculation Year 1 level of incentive (taken as the percentage difference between passing and contracted rent) fitted to an estimated average incentive realisation rate to ascertain an estimate of the full value of the discount including future years. This figure is adjusted by the current newly-signed time to first break to fit it to an equivalent discount over a set five year period. The percentage discount is then presented in terms of rent free months over a five year period.

Incentives This refers to the level of passing rent discount offered to occupiers as part of the lease agreement. Incentives in this report are measured as the differences between the contracted rent agreed and the actual passing rent received.

Income return The annual compounded rate of net income receivable per year expressed as a percentage of the capital employed over the year.

Rack rented Where the contracted rent (and potentially the passing rent) is equal to the OMRV. In a practical sense here, it is within 95%-105% of OMRV to rule out conversion and rounding errors, etc.

Rental growth The annual percentage change in either the open market rental value, passing or contracted rent, as expressly defined.

Time to first break The time duration in months between the start date of a lease contract and the contract expiry or a break that a tenant can exercise, whichever is sooner.

Total return The annual compounded rate of monthly capital appreciation, net of capital expenditure, plus monthly net income received expressed as a percentage of monthly capital employed.

Underrented A term used to describe when the contracted rent is below the open market rental value, which implies a positive reversion.

Void rate The proportion of vacant floorspace, expressed as a percentage of the total.

63

CONTACTS Agency London Mark Trowell Tel. +44 (0)20 7333 6323 mtrowell@geraldeve.com David Moule Tel. +44 (0)20 7333 6231 dmoule@geraldeve.com Josh Pater Tel. +44 (0)20 3486 3473 jpater@geraldeve.com Midlands Jon Ryan-Gill Tel. +44 (0)121 616 4803 jryan-gill@geraldeve.com North West Jason Print Tel. +44 (0)161 830 7095 jprint@geraldeve.com South West & Wales Richard Gatehouse Tel. +44 (0)29 2038 1863 rgatehouse@geraldeve.com Scotland Sven Macaulay Tel. +44 (0)141 227 2364 smacaulay@geraldeve.com

Investment John Rodgers Tel. +44 (0)20 3486 3467 jrodgers@geraldeve.com Nick Ogden Tel. +44 (0)20 3486 3469 nogden@geraldeve.com Callum Robertson Tel. +44 (0)161 259 0480 crobertson@geraldeve.com Lease Consultancy Chris Long Tel. +44 (0)20 7333 6444 clong@geraldeve.com Ian Gascoigne Tel. +44 (0)121 616 4812 igascoigne@geraldeve.com Rating Keith Norman Tel. +44 (0)20 7333 6346 knorman@geraldeve.com Valuation Richard Glenwright Tel. +44 (0)20 7333 6342 rglenwright@geraldeve.com Research Steve Sharman Tel. +44 (0)20 7333 6271 ssharman@geraldeve.com Ben Clarke Tel. +44 (0)20 7333 6288 bclarke@geraldeve.com

Offices London (West End) 72 Welbeck Street London W1G 0AY Tel. +44 (0)20 7493 3338 London (City) 46 Bow Lane London EC4M 9DL Tel. +44 (0)20 7489 8900 Birmingham Bank House, 8 Cherry Street Birmingham B2 5AL Tel. +44 (0)121 616 4800 Cardiff 32 Windsor Place Cardiff CF10 3BZ Tel. +44 (0)29 2038 8044 Glasgow 140 West George Street Glasgow G2 2HG Tel. +44 (0)141 221 6397

Leeds 1 York Place Leeds LS1 2DR Tel. +44 (0)113 204 8419 Manchester No1 Marsden Street Manchester M2 1HW Tel. +44 (0)161 259 0450 Milton Keynes Avebury House 201-249 Avebury Boulevard Milton Keynes MK9 1AU Tel. +44 (0)1908 685950 West Malling 35 Kings Hill Avenue West Malling Kent ME19 4DN Tel. +44 (0)1732 229423

Multi-let: Summer 2018

Multi-let is not intended to be definitive advice. No responsibility can be accepted for loss or damage caused by any reliance upon it. Š All rights reserved The reproduction of the whole or part of this publication is strictly prohibited without permission from Gerald Eve LLP Š Gerald Eve LLP 2018

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