Industrial real estate. The most talked about sector of recent years. A sector I have not been involved with much in my career so far, but looking ahead I undoubtedly will.
With this piece, I hope to learn more about the history of the sector, its technicalities and the current state of the UK market. I will also explore ideas and concepts for the future.
The Rise and Rise of Industrial Real Estate
Before getting into the fun part of making predictions, first some history and technicalities.
History and Technicalities
The history of industrial real estate is rather simple. The Cauble Group have a great take on it:
In the late 18th century, a new wave of technological, socioeconomic, and cultural revolutions began to influence the rapid shift of economies once dominated by largely rural and agricultural production.
This period of time, now known as the “industrial revolution,” played a vital role in shaping the way our global economic system works today.
Since the beginning of the industrial revolution, production of and transportation logistics for consumer goods have continued to evolve into the industrial complex that we know today.
This is the birth of industrial real estate as we know it. The industrial revolution. Two of its main drivers are consumption and trade. Consumption allowing for consumers and businesses to manufacture, store and deliver goods. Whilst trade enables the movement of goods between countries. In terms of location, industrial facilities have traditionally been adjacent to key transportation hubs such as seaports, highways, rail junctions and airports. More recently, city centre outskirts have become vital with the rise of last-mile deliveries. Looking at specifications, industrial units typically require specified loading doors, minimum eaves height, lorry and car parking bays as well as specified site coverage (ratio of floor area to site area).
Here, VTS look at the most common types of industrial real estate:
Manufacturing: Heavy manufacturing for giant plants which make heavy-duty equipment (shipbuilding or steel production). Light manufacturing is similar to heavy manufacturing but smaller more portable parts are assembled.
Storage and distribution: Buildings where products are stored and shipped. The most common are Distribution Warehouses (Amazon fulfilment centres). Other segments include General Purpose Warehouses used to store goods, or Truck Terminals serving as intermediate sites for goods being moved from one truck to another.
Flex Space: These serve multiple purposes including Research and Development (labs and testing spaces), Data Centres (network connectivity and data storage) and Showrooms (car dealerships).
That’s it for the theory. Now onto the current state of the UK industrial market.
UK Industrial Real Estate
I will keep this section short considering the amount of good quality content out there. A couple of good reports Gerald Eve, LSH, and BNP Paribas Real Estate.
Understanding the recent rise of industrial real estate has all to do with e-commerce. In order to fulfil e-commerce orders, warehouses are required to produce, store and ship the products. This rise has been further amplified by Covid and the consequent growth of remote work and the general shift to all things online. For context, online sales were 5% of all retail sales in 2008 and grew to 25% in 2022 (peaking at 38% during Covid).
A massive shift from physical to online needing to be matched by industrial space to accommodate. So far, supply has not been able to keep up with demand with tenants paying premium rents to acquire valuable space. Across the UK, rental growth rose on average 18% in 2021, 35% in London. For 2021, regions with the highest take up have been the Midlands (East and West), Greater South East (includes London), and North West.
Inevitably, land values have risen with investments pouring into the sector. The sector saw £15 billion in investments in 2021, accounting for 25% of all UK real estate investment, this versus the 10-year average of 13%. The high demand has led to yields compressing with the sector becoming safer and more appealing. I research the wider UK real estate investment market here.
As of writing (July 2022), the occupational market remains strong whilst the investment market has slightly cooled off. Many consider investment values to have peaked although very few consider us to be in bubble territory.
Let’s now look at some concepts which could shape the future of the industry.
The Future
What shifts can we expect? Below are some ideas which could impact the sector whether that be tech related, sustainability related, or shifting consumer demands.
Are Our Sustainability Targets Realistic?
This is something I discuss in my previous post. The post was based on the office market but the same principles apply to the industrial market. If we go by the research, 90% of existing industrial units (and offices) will need to be upgraded by 2030 to reach the new energy efficiency requirements. All that within eight years. In my view, an unrealistic task. I wonder if we have done enough research on the consequences of how much this will cost, how much labour will be required and how much pollution, traffic and chaos it will cause.
In any case, this will create opportunities as landlords’ will be forced to sell whilst others will see opportunities to buy distressed assets. We should have a good barometer next year as by April 2023 the minimum requirement for EPC will be lowered to E.
Less Expenditure For Industrial. Until Now.
Industrial units have traditionally required less expenditure than offices and retail. They also did not need to be located in prime city centres which attract premium rents. This is changing. In today’s world, more expenditure is required as units require the highest tech to enable automation and productivity. Additionally, they need to be closer to city centres to fulfil same day deliveries.
New tech will include drone deliveries on roofs, autonomous vehicles and robots. This means industrial units will need to adapt as they will require less driving space and new infrastructure on roofs to accommodate drones. Below is Boston Dynamics’ Spot in action. Whilst a funky video, the robot has many functionalities which should not be underestimated.
Drive Towards Sustainable Consumerism
A recent movement is the rise of 2nd hand shopping. As we shop more sustainably, we will think more about our impact on the environment. 2nd hand shopping means more recycling and less production. Additionally, we are likely to shift towards repairing products rather than replacing them (see Apple Repairs). An issue for fast fashion and products which are built to break down. If we are to consume less, the question is whether we require less space.
On the flip side, demand for warehouse space could increase for 2nd hand goods and repairs. As a result, retail warehouses could become more in demand with products sold and repaired on the spot.
Changing consumer dynamics
Regardless of the state of the economy, demand for industrial space is expected to stay. In part because e-commerce is not going anywhere but also because new players are entering the market. These include modular house builders (see TopHat), 3D house builders (see Icon), battery cell manufacturers (see BritishVolt), or electric vehicle manufacturers (see Arrival and Tevva).
This is no guarantee to be a success though. Recently, Countryside announced they are to close its loss-making £20m house building modular factory which was only recently opened.
Local Supply
Covid has shown us how quickly globalisation can come to a standstill. This has made companies and governments think about manufacturing locally. Whilst local manufacturing is more expensive, it does have the benefits of certainty and control. One example is farming. I consider this here looking at how vertical farming could add social, environmental and economic benefits to the local economy. With more local supply, comes more requirements for industrial space.
Final thoughts
Within years, industrial real estate has transformed itself from a sector on the periphery to the most talked about within real estate. This is not a short-lived trend with the sector not expected to go anywhere.
From an investment perspective, prices have peaked. Whilst not expected to crash, a certain correction is inevitable and already taking place. On the occupational side, new entrants such as modular housing and local manufacturing will play an increasing role, whilst local supply and a change in consumerism might impact how warehouses are built. Landlords will also need to consider the rise of technology & automation as well as new sustainability requirements.
A sector experiencing innovation at an unprecedented pace it is difficult to keep up. Whilst some innovations will work, others will not. Time will tell how the future of the sector will pan out.
This is the 2nd article with the new format, where before starting the article I share a couple of thoughts from the past months.
Starbucks and Kroger Enter Invest in EV charging stations: An example of a couple of retail brands taking the initiative and making good use of their parking space. The aim is to acquire loyalty from customers whilst serving as an additional revenue stream.
The Rise of Co-Living: A sector which keeps on growing and which many investors are keeping a close eye on. Many consider the sector to be a middle ground between student housing and build to rent. No doubt, I will soon be researching this sector more.
Japan House London: I recently went to their latest exhibition which I highly recommend. The exhibition is on until 4th September 2022.
Great exhibition at @japanhouseldn on the Island of Inujima. The Inujima Art House Project aims for art to bring life back into the island 🏝🇯🇵
Great Article!