The current run on the Australian industrial and logistics sector continues unabated and similar to the current mandated lockdown in most parts of the country; many are asking when will it stop? However, unlike being in lockdown, it's a great time to be an industrial and logistics property owner, with a sharp rise recorded in values over the first half of 2021. The sector continues to beat expectations, and the performance spread over the retail and office sectors is at record highs.
The sector's strong performance continues to be underpinned by e-commerce, and in turn, investors are re-weighting their portfolio's into industrial. This additional weight of capital has been the key driver behind the acceleration of yield compression in 2021, which occurred when many were expecting yields to stabilise. The recent A-REIT reporting season underscored the sector's strong performance as yields continued to fall and high occupancy and rental collection rates were recorded.
From a demand perspective, appetite for industrial and logistics assets has risen significantly off the back of the strong occupier market and favourable structural tailwinds. In H1 2021, approximately $8 billion in transactions had occurred (>$10 million) and compares to $5.5 billion for the entire 2020 calendar year. Since June 2021, the level of investment has further accelerated as a result of recent portfolio transactions. Portfolio transactions represented 65% of investment volumes in H1 2021, up from 28% in 2020.
The recent reporting season showed that the weighted average capitalisation rate (WACR) of the major A-REITs industrial assets firmed by 49 basis points (bps) over the six months to June 2021 and 75 bps over the past year. As a result, as of June 2021, the WACR of the A-REITs industrial assets measured 4.61%, down from 5.35% in June 2020.
While this level of compression is significant, particularly compared to other sectors in the current environment, recent benchmark industrial and logistics sales imply there remains scope for further compression in the second half of 2021. These transactions include:
- The McPhee Logistics Portfolio, which Dexus recently purchased on a yield of slightly above 4%;
- 5-17 Leslie Road, Laverton North which Mapletree acquired on a 4.30% yield; and
- The Mirvac and Morgan Stanley portfolio, which Lendlease acquired on a 4.00% yield.
Based on recent transactions and our view on where yields currently sit within the sector, the upside to A-REIT industrial and logistics valuations is in the order of 10-15%.
Australian REIT Industrial Cap Rate Analysis
Colliers Research Q2 2021 data shows that the rate of yield compression has been strong in all capital cities, albeit most pronounced within the Adelaide (-72 bps) and Brisbane (-68 bps) markets. In some respects, this represents a catch-up period to the Sydney and Melbourne markets, which saw significant growth levels of compression in Q1 2021.
As a result of the large re-rating and pricing shift within the sector over the past six months, for the first time on record, industrial and logistics yields are now lower than CBD office yields. Historically, a discount of 100 basis points or more was applied to industrial and logistics assets when compared to the CBD office and Regional retail assets. However, the favourable macro drivers supporting heightened occupier demand levels have re-balanced the yield pendulum, with sharper yields recorded for industrial assets. Nationally, the average prime industrial yield measures 4.54% and compares to prime CBD office yields of 5.13% and regional retail centre yields of 5.53%.
Australian Commercial Property Yields by Asset Class
From an occupancy perspective, the vacancy rate among the A-REITs with industrial assets sat at 2.7% in June 2021, compared to 3.3% in December 2020. This vacancy level is below the broader national average of 3.5% for the same period and highlights the lack of leasing options at the institutional end of the market.
National Industrial Vacancy Rate
Where to from here?
Recent sales evidence has provided significant upside to industrial and logistics values for H2 2021. In our view, yield compression is expected to continue for the remainder of 2021 before stabilising in early 2022. By this point, average prime yields are expected to sit closer to 3.5% in Sydney and Melbourne while Brisbane will be closer to 4.0%. For Adelaide and Perth, sub 5.0% yields are expected to become more prevalent. Similarly, with a pick-up in rental growth expected due to heightened tenant demand and the low level of leasing options, capital values are expected to grow substantially in H2 2021.
Prime yields at a national level are now sitting 236 basis points below the 10-year average and 256 basis points below the last market peak in early 2008. Comparing against the 10-year Government bond yield, forecasts indicate this will sit at ~1.8% by Q4 2021, providing a spread between the low end of the prime yield range of 170 basis points. While this spread has narrowed significantly, it remains well above the 79-basis point spread recorded before the GFC in early 2008. In addition, with interest rates expected to stay at 0.1% until late 2022 or 2023, the spread to the low end of the prime yield range is at a healthy level at 340 basis points.