Distribution sector update

• Take-up and rental levels are holding up well, with a minimal impact on incentives. H1 take-up for industrial / distribution units over 50,000 sq ft across our markets was only 3% below the five-year average, at 4.8 million sq ft across our locations. However, this was boosted significantly by one ‘mega-deal’ - Amazon’s 2.3 million sq ft pre-let in Dartford.

• Online retailing is driving requirements, with many retail chains switching from in-store or closing outlets. We have also seen many short-term lettings directly related to the COVID-19 pandemic. However, demand is considerably more broad-based, with a robust level of requirements from the manufacturing and engineering sectors, and also for data centre space.

• A lack of supply in key locations remains a feature and the level of disposals has been relatively modest so far this year, given the turbulent economic conditions. However, the secondary market is likely to experience a rise in vacancy as more insolvencies are announced and some short-term COVID-19 space is released back to the market over the medium term.

• Re-shoring is much talked about, but will take many years to accomplish, although some Brexit-related space may be needed in the short term.

• Headline rents and incentives have been broadly static so far this year and a significant fall in rental values appears unlikely given the resilience of the sector, despite the wider economic uncertainties.

• The investment market has held up well, with industrial transactions totalling just over £620 million across our locations, and values are being maintained at the prime end.

We have monitored industrial / distribution deals of over 50,000 sq ft across our core commercial locations of Bristol/Bath, Birmingham, Cambridge, Leeds, London/M25 and Oxford. This shows a robust picture during the first half of 2020, with take-up totalling 4.8 million sq ft, just 3% below the six-monthly average over the previous five years, and 6% above the take-up during the first half of 2019.

However, the 2020 figure was boosted by one ‘mega-deal’, Amazon’s 2.3 million sq ft pre-let at Tritax’s Littlebrook scheme in Dartford. Other sizeable deals included The Range signing a 20-year lease for 547,000 sq ft at Poundworld’s former unit at Normanton; and Great Bear Distribution taking a speculative 335,000 sq ft unit at Tritax Symmetry’s Central M40 in Banbury on a 15-year lease.

Although not appearing in the figures for H1, Amazon has also just taken a 2 million sq ft pre-let at Gateway 45 in Leeds’ Aire Valley Enterprise Zone, subject to planning approval, and this will boost the figures for the second half of the year. We are likely to see an increasing number of larger transactions, with deals over a million sq ft becoming more commonplace.

There has been a rise in short-term lettings to cope with immediate COVID-19 impacts, most notably from the NHS and the major supermarkets. Landlords are generally willing to consider short-term lettings, particularly if there is a possibility that they could become longer-term.

However, we are also seeing many longer-term requirements, with an increase in enquiries in recent weeks. In some markets, demand is now stronger than pre-COVID-19, although there remains the question of how many will be converted into actual transactions.

Unsurprisingly, demand for last-mile delivery space has surged, with online sales currently accounting for nearly a third of all retail spending in the UK, compared with less than 20% this time last year. A good example is parcels carrier Hermes, who are planning to expand their workforce by over 10,000, including 1,500 in Leeds, and have a number of active requirements across our markets. Buoyant urban demand also extends to land for uses such as van parking and open storage.

General sentiment is extremely strong across our markets, although some sectors have been adversely affected, for example fashion and some parts of the manufacturing sector (notably automotive).

Demand is being driven by online retailers, including retail chains switching from in-store to online (and closing stores), as well as parcels carriers and supermarkets. However, there is a much broader spectrum of firms looking for space, ranging from manufacturers and engineering firms to medical suppliers. There is also very strong demand for data centre space, driven by increasing data storage requirements associated with home working.

A lack of supply in key locations remains a feature. In some cases, space is becoming available as firms rationalise, and this is enabling market churn. However, the level of disposals has been relatively modest so far this year given the turbulent economic conditions. Older units can still let well if the specification is right, the unit is adaptable, or it is well-located.

However, we think that the secondary market could well see a rise in vacancy rates as more insolvencies are announced, particularly in areas such as store-based fashion. In addition, some of the short-term COVID-19 space will be released back to the market from organisations such as the NHS.

Developers are understandably cautious about speculative schemes, although there is still activity. An example is the Oxfordshire market, with speculative development at Axis Point in Bicester, Didcot Quarter and Tungsten Park, Witney. High street lenders are undoubtedly more cautious on commercial property lending generally, although the institutions as well as private investors and well-financed property companies remain keen.

There has been much conjecture around a greater requirement for storage and distribution space, as corporates increase the resilience of their supply chains in the wake of COVID-19 through reshoring some of their production, and also in preparation for Brexit. In a recent IAS survey, 70% of respondents cited that the logistics / supply chain sector will change to a different model to allow greater flexibility as a result of the pandemic.

Re-shoring will be a relatively long-term trend, as it will take many years to accomplish, and the extent will vary significantly by business sector. However, some Brexit-related demand may be needed quickly, for example to accommodate additional space for customs procedures.

Headline rents and incentives have been broadly static so far this year, although in some cases incentives have increased a little, particularly with occupiers concerned about their cashflow. Indeed, the MSCI Monthly Index reports a modest rise in average rental values of 0.8% during the first six months of the year.

Given the shortage of supply and robust enquiry levels, a significant fall in rental values appears unlikely despite the wider economic uncertainties.

Overall, the industrial and distribution investment market remains extremely strong, with a remarkable amount of UK and international cash looking to invest in the sector. The strength of demand means that even management-intensive estates are seeing strong interest, although there is more nervousness around buying vacant possessions. There is also strong appetite from occupiers wanting to purchase freehold, notably in the sub-£5 million price bracket.

Transactions across our locations totalled a respectable £622 million during the first half of 2020. The resilience of the sector can be seen by comparing Q1 against Q2. Industrial investment actually increased in Q2 compared with Q1, from £166 million to £456 million, whilst activity fell in all other key property sectors. In Q1, industrial and distribution accounted for 3% of the total value of purchases, but this rose to 23% during Q2.

Key transactions included the purchase of the 23-unit Perivale Park in Greenford, West London by SEGRO for £202.5 million, at a net initial yield of 3.12%. The low initial yield reflects strong reversionary potential within the estate, which is fully let and also has some development potential. The half-year saw a number of other distribution deals concluded at sub-4%.

Another significant transaction included in the figures is Aviva Investors agreeing a sale and leaseback with Next on three logistics warehouses at South Elmsall, between Wakefield and Doncaster, totalling circa 1.2 million sq ft, for circa £119 million, reflecting a net initial yield of 4.5%.

In some areas we have seen an appreciation of land values, although pricing has been stable in most locations. There is little evidence of a significant impact on capital values so far this year at the prime end of the market, and the sector will continue to prove resilient in the face of the wider uncertainty across much of the commercial property market.