_East Coast Australian industrial rents spurred by new generation logistics users

The upswing of retail, food and logistics tenants seeking premium accommodation has triggered a round of construction. With these developments spurring higher rents, rental growth has spread to the wider industrial market.

Jennelle Wilson April 16, 2019

The industrial market is poised to take advantage of the changing investment climate away from a focus on capital growth through cap rate contraction to more of an income-based investment paradigm. With the major East Coast markets all recording sustained rental growth, asset allocation into this sector is set to increase.

It is no secret that rental growth in the major industrial markets has been scarce since the GFC with 10-year average rent growth below 2% y-o-y for each of the East Coast cities. This turned around in Sydney in early 2017, followed by Brisbane and most recently Melbourne as the balance between tenant demand, available space and land values shifted, sending rents higher with 7.5% - 10% total rental growth across the three markets in the past two years.

Structural Shifts in Demand

At its heart, rental growth has emerged due to the type and quantum of demand from logistics occupiers as omni-channel retailing becomes entrenched in the supply chain. Structural shifts are as clearly visible in the industrial market as the office market in terms of what tenants expect from their space, albeit in different directions.

While office space is morphing towards space as a service with concierge facilities, shared spaces and flexibility of occupancy all key concepts for office users, industrial tenants are more concerned with the efficiency of location and a flexible, large-volume building shell with high green ratings.

These demand shifts are related to the vagaries of human nature – office users want to keep the humans they employ happy, so they won’t go and work for their competitor. In contrast industrial space users want to keep the humans that buy from them (or their client) happy by delivering accurately, cost effectively and quickly so they won’t buy from a competitor.

"There is substantial investment into automated systems from major retailers, food manufacturers and logistics service providers"

As a result, there is substantial investment into automated systems from major retailers, food manufacturers and logistics service providers. In Sydney (21,710sqm) and Brisbane (48,750sqm) Australia Post has pre-committed to purpose-built parcel sorting facilities on 15 year leases for $130/sqm and $136/sqm net respectively. Australia Post will fill these buildings with advanced sorting machinery.

Additionally, Coles has launched a programme to upgrade its warehouse facilities and automation to improve efficiency and reduce costs with 20 year commitments on 66,000sqm buildings to be constructed in Sydney and Brisbane. Woolworths opened the first of their new automated warehouses in Dandenong South, Melbourne last year and will also pursue a programme of upgrading their distribution centres.

Longer term planning horizons for logistics operators

In the past the logistics firms would often lease warehouse space for a client, with the lease aligned with the contract term. However, the required investment in technology now means such short planning horizon may not be longer suitable, particularly where there is high-volume turnover of many product lines.

"It has become apparent that the cost and time savings inherent with these new central hubs has resulted in tenants accepting higher rents and investing significantly on technology themselves."

As an example, Toll’s Ecommerce fulfillment centre at Prestons, Sydney was anchored by a long-term commitment from Specialty Fashion Group as the level of design and machinery involved required long term investment. The centre is also designed to be multi-user which signals greater centralisation of facilities by the large logistics operators, as opposed to the previous more ad hoc approach to sourcing warehouse facilities.

Centralised facilities require strategic locations within the road network and it has become apparent that the cost and time savings inherent with these new central hubs has resulted in tenants accepting higher rents and investing significantly on technology themselves.

Supply Squeeze

Since construction levels peaked at 2.4 million square metres in 2008, East Coast supply has been roughly half this, averaging only 1.2 million square meters per annum through to 2017. This sustained supply squeeze saw vacancy levels, fall encouraging rental growth for quality assets. Additionally, the unsuitability of existing stock for many tenants, shifted demand to the pre-commitment and speculative development market. This shift was particularly evident in Sydney and Melbourne taking construction completions to 10-year highs in 2018.

Land Prices Jumped

The combination of competing land uses such as residential and the virtually insatiable demand from local institutional developers to control industrial landbanks saw prices jump across the board. In Sydney land values have effectively doubled since 2016, while land in the West of Melbourne is up by 40% in the past year. In Brisbane 1ha+ land parcels have increased in value by 16% over the past two years with the South East precinct outperforming with a 34% increase. These higher land costs meant that higher rents were required to reach feasibility and spur development.

Rental Uplift is not yet universal, but signs are positive

Rental growth was triggered by the demand for premium buildings, unlocking a clear rental premium for newly built accommodation. However, this has now flowed over into the wider market. Looking ahead the elements which triggered rental growth remain in force – relatively low vacancy, subdued future construction expectations and ever-increasing land input costs.

"Looking ahead the elements which triggered rental growth remain in force"

With Sydney vacancy below the long term average since 2015, Melbourne vacancy at five year lows and Brisbane vacancy back below the average for the first time in five years, fundamentals appear poised for further rental growth. As the stock of development land is falling quickly, the time and expense to deliver the next phase of land supply will support ongoing rental growth by moderating the future supply pipeline in the short term and the facilitation a further rental uplift for new construction in the longer term.

For more in-depth analysis of East Coast industrial markets see our most recent research reports for Sydney, Melbourne and Brisbane or for the latest major industrial leasing opportunities see Knight Frank's Space Industrial publication.