In a booming industrial and warehouse market, where demand outstrips supply, the tenant selection process from a landlord’s perspective can often create somewhat of a dilemma. On a new multi-unit scheme, do you take the ‘bird in the hand’ approach in order to minimise void? Or hold out for the sought-after AAA covenant that will drive investment value? Indeed, 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 where land is in scarce supply and trading at a premium. Add to this the appetite from the institutional sector, and we now find ourselves in a situation where rents, lease lengths and covenant aspirations are being stretched to the limit.
With gross industrial land values in North and East London now exceeding £3 million and £5 million per acre respectively, every input 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 has reduced quite substantially from Q3 2017 to Q1 2018, falling from 14.9 million sq ft to 10.5 million 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. But, what we’ve actually seen is take up tail off towards the end of 2017, standing at 7 million sq ft – 3% below the 10-year average for the eastern half of the M25. On this basis, you can’t help wonder how much these take-up figures are being suppressed, in part, by the stringent tenant selection process.
To this end, the industry’s agency network may be complicit as we too have helped significantly drive rent upwards, much to the benefit of our landlord client base. But, in doing so, do we now find ourselves in a situation where a large proportion of our core traditional applicant base – most of whom have very strong balance sheets – are 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 corporates undoubtedly have the covenant, their requirements are also finite. Having acquired in a specific location, they are very unlikely to have another requirement there for some time, meaning are landlords holding out with overly-optimistic expectations?
An unintended consequence of this has been the creation of a two-tier market – especially within many key strategic M25 locations; one where only large corporates and exceptionally well-funded SMEs can either afford or will be accepted. But, as footloose or under-financed SMEs are pushed out into fringe locations, these areas are beginning to benefit from increased opportunities and investment into the local economy, proving that, what is the inner M25’s loss will soon turn out to be the outer M25’s gain.