In a booming industrial and warehouse market where demand outstrips supply, from a landlord’s perspective, the tenant selection process can often create something of a dilemma.
On a new, multi-unit scheme, do you take the ‘bird in the hand’ approach to minimise voids or hold out for the sought-after AAA covenant that will drive investment value? An increasing number of landlords are opting for the second approach.
The industrial and logistics market is becoming an increasingly attractive investment opportunity – partly due to the urban logistics sector, where market demand is focused on built-up locations, land is scarce and trading has a cost premium.
Add to this the appetite from institutions and we find ourselves in a situation where rents, lease lengths and covenant aspirations are being stretched to the limit.
This is especially true within the M25. With gross industrial land values in north and east London now exceeding £3m and £5m per acre respectively, every element in the development appraisal needs to be maxed out to generate the required returns.
According to Glenny’s Q1 2018 Databook, published earlier this month, demand within the eastern M25 region has fallen substantially between Q3 2017 and Q1 2018, from 14.9m sq ft to 10.5m sq ft – mostly in the 50,000 sq ft-upwards bracket.
Nevertheless, demand is still outstripping supply by some margin. Given the continuing appetite for stock, it would be reasonable to expect take-up to remain high.
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Yet take-up actually tailed off towards the end of last year, standing at 7m sq ft – 3% below the 10-year average for the eastern half of the M25. On this basis, you can’t help but wonder how much these take-up figures are being suppressed, in part, by the stringent tenant selection process.
The industry’s agency network may be complicit in this. We have helped significantly drive rents upwards, much to the benefit of our landlord client base, but in doing so, we have created a situation where a large proportion of our core traditional applicant base – most of which has very strong balance sheets – is no longer able to compete on either a rental or covenant basis with the large corporate e-retailers and logistics providers.
This situation throws a second dilemma into the mix. While these large corporations undoubtedly have good covenants, their requirements are also finite. Having acquired space in a specific location, they are very unlikely to have another requirement there for some time, meaning that landlords may be holding out with overly optimistic expectations.
An unintended consequence of this has been the creation of a two-tier market – especially within many key M25 locations – where only large corporations and exceptionally well-funded SMEs can afford space or will be accepted by landlords.
However, as footloose or under-financed SMEs are pushed out into fringe locations, these areas are beginning to benefit from increased opportunities and investment in the local economy, proving that what is the inner M25’s loss will soon turn out to be the outer M25’s gain.
John Bell is partner at Glenny and head of the business space and investment agency division
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