UK Industrial Spotlight – September 23

Key headlines

• The latest monthly data on CPI inflation and quarterly GDP are more positive than their respective prior readings. In July, the annual inflation rate slowed more than it had in June, and GDP grew at a slightly higher rate in Q2 compared with Q1.
• Industrial rents are still growing, although more slowly. Prime investment yields are trending stable. 
• In the industrial market, industrial open storage (IOS) is attracting more attention, but it remains a niche part of the market overall and needs more transparency to attract significant wider interest and transition further. 

Recent economic and market indicators

• CPI inflation rose by 6.8% in the 12 months to July 2023, down from 7.9% in June. Base Rate was raised to the current level of 5.25% on 3 August (prior to the release of the latest inflation data). The slowdown in CPI was more than generally expected and, as a result, forecasts are now typically pointing to Bank Rate peaking at 5.50% by the year end, as highlighted by the August Consensus Economics survey. But the rate could stay higher for longer, given that the Bank of England does not expect inflation to come down to around its 2% target level until early 2025, according to its August Monetary Policy Report.
• The first estimate for Q2 2023 real gross domestic product (GDP) shows that the UK economy grew by 0.2%, following growth of 0.1% in Q1. GDP in Q2 was 0.4% higher compared with the same quarter a year ago. However, the level of GDP in Q2 2023 is still 0.2% below its pre-COVID level. 
• A summary of the latest medium-term forecasts published by HM Treasury in August points to a gradual improvement in the rate of GDP growth. The average of independent forecasts is 0.8% in 2024, followed by 1.7% in 2025 and 2.1% in 2026. Growth this year is expected to be a lacklustre 0.2%.

Industrial rents still going up

JLL’s latest data based on our assessment of prime headline rents shows further industrial rental growth in Q2, a trend supported by the the release of the latest MSCI quarterly index data.

According to JLL, based on 32 market locations, UK prime headline rents in the big box logistics market rose 1.8% in Q2 and were 5.9% and 9.5% higher than six and 12 months ago respectively. Based on 62 markets, prime headline rents for UK standard industrial units between 10,000 and 20,000 sq ft were 0.6% higher over Q2, 4.8% higher than six months ago and 8.6% up on the same time last year.

According to the MSCI Quarterly Index, UK industrial rents rose 1.7% in Q2 and were 7.7% up on 12 months ago. Therefore, while the pace of rental growth is moderating it still remains reassuringly positive for investors/developers.

Latest data highlight an increase in industrial investment transactions while pricing remains stable 

The total volume of UK industrial & logistics investment transactions in Q2 2023 was some £1.46 billion, roughly double the level posted in Q1, according to JLL’s latest data. As a flavour of recent transactions:

• Tritax bought a 3-unit scheme of c.185,000 sq ft in Enfield, London from IM Properties for £50.5 million, reflecting a net initial yield of 3.86% and a reversionary yield of 5.15%.
• Debt backed Valor, bought the 341,000 sq ft Tetra estate in Greenford, London for £126.9 million, reflecting a net initial yield of 2.88%, a reversionary yield of 6.18% and an equivalent yield of 5.5%.
• Mileway bought a 71.3 acre industrial open storage site at Ridham Dock, Sittingbourne from CEG for £52.5 million reflecting a net initial yield of 4.98%.

In our assessment prime industrial yields have remained stable over recent months and at the end of August were around 4.75% in London, 5.00% in the South East and 5.25% in the core regional markets for both single-let distribution and multi-let industrial assets.

JLL has been involved in c.£500 million of industrial capital market transactions in the UK over the past two months and there remains a good amount of capital chasing the sector. The core end of the market is holding up well, but secondary and tertiary assets could come under additional pressure if interest rates rise further, as the buyer pool has thinned partly because investors have become more ESG conscious.

Spotlight on Industrial Open Storage market

There is nothing new about industrial open storage (IOS) but over the past couple of years it has certainly attracted more attention and commentary with some speculation that it could establish itself as a new industrial growth ‘sector’ in the UK. In our view, whilst we are seeing some changes in the IOS market, at this stage it remains a relatively small niche, which in most cases is based on marginal sites that are typically difficult, or unviable, to develop, or on sites that are offered for IOS as an interim use, pending development. To date we have not seen a significant evolution away from these traditional features toward an emerging new sector, despite a limited number of good examples that highlight the potential for change.

The IOS market is highly fragmented in terms of providers and has traditionally serviced the requirements of a relatively limited range of occupiers, such as those requiring land for vehicle storage, the storage of equipment and materials for construction, or for temporary container storage. In many cases, the quality of sites was relatively poor as was the covenant strength of many occupiers.

However, over recent years the occupier base has become more diversified. For example, the growth of e-commerce has led to wider requirements for vehicle fleet storage beyond that provided at distribution/depot facilities, and the transition to vehicle electrification is leading to growing demand for land for vehicle charging.

In addition to rising demand for IOS, the supply of IOS sites has fallen as many private owners have sold sites to developers during the booming industrial market as well as sites being lost for transport projects and other uses such as residential (particularly in London) . As a result, demand and supply dynamics have driven good recent rental growth in IOS rents (especially in London where £10 per sq ft is being quoted on a Park Royal IOS site) and attracted the interest of new investors. These investors are generally seeking to provide higher quality sites (incorporating better quality surfaces, enhanced security and lighting and 24/7 access) specifically for long-term IOS. Rents are achieving higher levels particularly in London, as open storage opportunities are rare.

Examples of recent new investment in the IOS market include Surface, a joint venture (JV) between NW1 Partners and Marchmont, with sites at Ashford in Kent, Colnbrook and Streatham; a JV between Peloton and Moorfield Group announced in 2022 with plans to invest an initial £100 million into a UK platform of IOS sites; and Open Site Ltd, formed in 2021 which currently has sites at Thurrock, Dartford and at Hams Hall, near Coleshill. In addition, Tristan Capital Partners has recently acquired two port development sites in Colchester and Birkenhead respectively which it intends to develop with Tungsten Properties, with the 22-acre Ark Royal site in Birkenhead earmarked for a single big box unit of circa 495,000 sq ft, plus around 11 acres of open storage. Also, as noted above, Mileway recently acquired the 71.3-acre Ridham Dock site in Sittingbourne for industrial open storage.

Quite clearly the IOS market is changing in part and the provision of the better quality, long-term IOS sites is welcome. In the United States IOS is an established and mature market, but, at present, it is too early to talk about this being the case in the UK and any transition to such a status would, in our view, require a greater level of market transparency. Nonetheless, we expect growing interest from investors going forward due to favourable demand and supply dynamics, so this is certainly a market niche to closely watch.