Taurus Developments’ Managing Director, Michael Gibbens, looks at development funding across the mainstream industrial market.
During the race for UK logistics space, many industrial assets around the country – that will most likely never have a fulfillment application – have benefitted from a ‘halo effect’ of newly-found relevance. Essentially, any asset with a location close to a conurbation, reasonable footprint and some sheds on it was eyed as having a potential future logistics use. The reality, of course, was never that straightforward.
A huge number of ‘mid-range’ shed schemes in the 3 to 15 acres bracket are there to service demand from a multitude of businesses – the vast majority of which are not involved exclusively in the logistics sector. However, the sheer weight of investment into the UK warehouse sector that was fuelled by new levels of e-commerce created during the pandemic caused ‘all boats to float’. Accordingly, if you were appraising a mid-range development scheme in recent times you’ve had to take into account the unprecedented level of investor demand for any opportunity which was perceived to have a potential logistics application.
According to CBRE, UK logistics occupational take-up in Q3 of this year was down 30% in comparison with the corresponding quarter in 2021. With that part of the warehouse market having cooled somewhat, it’s interesting to see what the knock-on effect may have been on the sector’s investment marketplace.
To do that you need to dig into the psychology of the development funding process. Traditionally, a developer and their funding partner would have a view on what the final value of a scheme would be in typically two years’ time when it was finished and let. Their considerations would also factor in planning, construction and leasing risk.
Together, this would reflect a discount to the value of current up-and-let investments in order to reflect the material uncertainty of delivering a product into the market at a time in the future when you cannot know with certainty what the prevailing market conditions will be regarding rental levels and occupier demand.
However, because we’ve seen such fierce demand for sites across the UK in the past five years, that material uncertainty buffer zone had to be reduced in order to make bids competitive. In doing this, there was the reassurance that the market did not have – as there has been in some previous cycles – a huge amount of speculative space which would quickly remove rental pricing tension if there was a change in economic conditions.
Today, the ‘read across’ from slightly softened yields in the logistics sector to the mainstream industrial market has essentially restored that material uncertainty buffer zone and that’s to be welcomed.
Although it is now more muted, there is still investor appetite for standing warehouse investments which are well located, well-let and, of course, priced correctly. However, there is now a growing case for there being more long-term value in development funding rather than standing investments as investors apply a greater discount in yield requirement for the former.
This is because the mid-range shed market in which we specialise is underpinned by a multiplicity of occupier demand and that brings resilience. Recent lettings at our schemes have been to an engineering company; a wholesaler; a business involved in the defence industry; and an installer of domestic boilers. This just begins to illustrate the broad base of demand for mainstream warehouse space.
As long as there is not over-development in our market then that broad base will continue to underpin demand and make development schemes which are completing in two years’ time robust.
In contrast, by buying standing investments now you are, by definition, paying ‘today’s price’ which still reflects the current weight of capital aimed at that area of the warehouse market. A change of sentiment in this area may be connected to the fact that some investments that were being offered in the market have now been withdrawn as investors try to look beyond the current economic and global turbulence.
And, of course, institutional investors are primarily focused on creating income streams to match liabilities rather than trying to spot where they might be able sell on an asset. This brings a wholly different attitude and is predicated on the supply-demand space equation and the fundamentals of where a warehouse product is and what market it will serve long-term.
During the past few years as yields progressively sharpened and values rose, it was hard to find a UK warehouse development project that hadn’t been profitable. While, as the saying goes, past performance is no guarantee of future results, the structure of the mainstream UK warehouse sector looks well set-up to deliver. It may not be as glamorous as the ‘big box’ market but the fundamentals are sound.
This viewpoint first appeared on ReactNews.com on 8.11.22