Logistics property market: changes

Continuity and change

10 May 2016

There has been much discussion of the factors affecting the UK logistics property market, but is it really all change? Jon Sleeman gives an overview

Property commentators often focus on change – the ‘changing landscape’ or a new ‘game-changer’ – while ignoring what has stayed the same. But if we look back over recent years, we can see both continuity and change. Indeed, a key challenge for participants in the UK logistics market, particularly occupiers, developers and investors, is evaluating all the changes that are going on and deciding whether, and how, they affect property and location requirements. At the same time the fundamentals of building specification and location for logistics facilities have not significantly altered.

Market conditions have undoubtedly altered over the past 5 or so years, however. At the start of 2010, the UK economy was just emerging from a deep recession and the logistics market was awash with empty space. Developers and landlords were prepared to drop rents or give large incentives to tenants and there was no appetite for speculative development. Prime investment yields ranged from around 6.5% in London to 7.5% in the major regional markets, with secondary yields significantly higher. By the end of 2015 many locations had an acute shortage of stock – the national vacancy rate is just 6% – rents are rising, and speculative development is picking up. Prime yields are close to their previous cyclical peak in 2007, although now they offer a premium over gilts, whereas back then the premium was negative (Figure 1).

Figure 1: Prime distribution yields

E-commerce

Some of the market drivers have also changed. In general, occupier demand for logistics facilities is driven by business growth and supply chain changes, with the rise of e-commerce the most obvious of these. E-commerce is transforming the UK retail market and driving significant and rapid changes in distribution networks. In the property market, this has manifested in growing demand for different types of logistics facilities including: super-sized fulfilment centres, where the stock is held and picked at item level; parcel sorting centres and local delivery centres; ‘dark stores’ for the fulfilment of online grocery orders; and returns-handling facilities.

Some property linked to e-commerce is quite different from the standard ‘big box’ logistics buildings, particularly the sorting and local parcel delivery centres, which are designed for rapid throughput rather than storage. These buildings are typically long and thin, with lots of doors and low site densities (Figure 2). In addition, because e-commerce requires efficient ‘last mile’ solutions, it is one of the key drivers behind the rising importance of urban logistics, which is encouraging demand for mainly urban, mid-sized box properties, as opposed to big box logistics on motorway corridors.

Figure 2: New parcel depot developed by SEGRO for Geopost at Enfield

Other drivers

Sustainability has been gradually rising up corporate agendas, and for some companies this has clearly influenced the buildings they have procured – for example, Marks and Spencer’s distribution centre (DC) at Castle Donnington or Sainsbury’s DC at Prologis Park, Pineham. However, for most companies, sustainability is still nice rather than essential, considered first and foremost in terms of potential to save money rather than reduce carbon emissions.

Rail freight has become more important over time but has had a relatively limited impact on the logistics property market. Between 2009/10 and 2014/15, rail freight increased by 16.5%, with domestic intermodal freight, including the movement of containers from ports, up 17.8% and Channel Tunnel traffic up 35.9%, but from a much lower base (see the Office of Rail and Road's display report). As a result, there is more demand for logistics properties on rail-connected sites, such as ProLogis’s Daventry International Rail Freight Terminal development (DIRFT; Figure 3). But the overall impact has been modest. Even now, JLL estimates that only around 10% of the total grade-A logistics stock in buildings of 9,300sqm and over is on rail-connected sites, while very few buildings have dedicated rail sidings.

Figure 3: Rail-connected distribution buildings at DIRFT

Port-centric logistics, which was initially promoted in the UK by PD Ports at Teesport and the Port of Felixstowe, has not radically reshaped logistics networks, in part because many UK ports have limited potential to accommodate very large new facilities. However, the opening of the new port at London Gateway and the adjacent park, with capacity for around 859,000sqm of logistics space, has significant potential.

Finally, while automation has become more widespread in logistics properties, comparatively few warehouse operators have to date invested heavily in facilities such as automated storage and retrieval systems (ASRS) and automated sorting systems.

Specification and location

Changes in the UK logistics market have not significantly altered the type of buildings that most operators require; neither have they radically changed the geography of the UK logistics property market. With some exceptions – such as parcel hubs – new logistics buildings are very similar to those built 5 or 6 years ago in terms of their key dimensions and attributes. The changes in building specification that have occurred over the past 5 or so years have been relatively gradual, including, for example, 15m eaves becoming more common, 50m yard depths becoming an absolute minimum, and potential changes in floor specification due to the increasing call for mezzanine floors.

In addition, the core logistics locations today – which attract the strongest occupier demand and have the largest clusters of development – have not significantly changed over the past 5 years and remain focused on the country’s strategic motorway corridors, particularly in the South East, the Midlands and the North West. Indeed, if one maps the location of large logistics properties taken up over the past 5 years, or the new speculative development that has taken place over the past 3, the evidence suggests that the market has seen a reaffirmation of core locations compared with a more dispersed market geography during the last boom.

A range of factors

Looking forward over the next 3 to 4 years, occupier demand for logistics facilities in the UK is likely to remain healthy, due to continuing economic growth and supply chain changes, including the further growth of online retail. As a result, we anticipate further speculative development, with the level of completions in 2016 likely to be double that in 2015. National distribution rental values are likely to increase by between 3% and 4% per annum in the 4 years 2016-19, according to JLL’s recent forecasts. This positive occupier market and rental growth will sustain strong investor appetite.

In terms of market drivers, e-commerce is likely to remain the key cause of change. It will contribute to the growth of urban logistics, and in London, where industrial land is rapidly diminishing due to housing demand, we could see some development of multi-storey, ramped warehousing. Sustainability will become more important, particularly now that the Minimum Energy Efficiency Standards (MEES) have been passed into law (see the related isurv feature on mitigating risks associated with MEES). These standards make it unlawful for properties with an F or G Energy Performance Certificate (EPC) to be let, without implementing cost-effective energy efficiency improvements or fulfilling an exemption criterion. The standards come into effect in April 2018 for new leases and lease renewals or extensions that already have an EPC, and in April 2023 for all existing leases. Although modern logistics properties are unlikely to be affected, older buildings could be.

Rail freight and port-centric logistics are also likely to become more important, with port container traffic leading to rail freight growth, partly due to new port investment – for example at London Gateway and Liverpool 2. Longer term, the development of High Speed 2 will release capacity on the West Coast Mainline, freeing additional capacity for freight.

Warehouse automation will become more significant as part of the wider move to automation and robots. This will change the existing economic and employment benefits associated with logistics properties (See the British Property Federation's Delivering the goods). Over time, the wider adoption of automation could have a significant impact on the type of buildings that occupiers require and the labour they need, which could also affect their choice of location. In the longer term, this could be the most important driver of change in the UK logistics market.

Jon Sleeman is Director of Research at JLL

Further information

This feature is taken from the RICS Property journal (March/April 2016)