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No longer the poor cousin - Spotlight continues to shine on industrial real estate

Gone are the days where industrial property was considered the poor cousin to office and retail with shinny sheds being more sought after in many cases than premium CBD office buildings and regional retail centres. Much like what occurred at the beginning of COVID-19 with rising demand for consumer staples, industrial property is high on the shopping list for most investors and this weight of capital is driving further yield compression.

The Australian industrial and logistics sector continues to be the standout performer in commercial property, highlighted by the recent reporting season of Australian Real Estate Investment Trusts (A-REITS) and commercial property returns for 2020 from MSCI. Across the board, the A-REIT results showed that in H2 2020 the rate of cap rate compression for the industrial sector has accelerated, occupancy remains elevated and rent collections were strong despite challenging operating conditions for some occupiers. Similarly, the sector provided a total return of 13.9% for 2020, significantly above the 4.7% for office and -10.1% for retail over the same period.

This strong result for the sector continues to be fuelled by the acceleration of online retail, growth of food logistics and occupiers’ commitment to optimising their supply chain network. In turn, vacancy rates across most capital cities remain low by historical standards as underlying demand outstrips availability, particularly in the Sydney and Melbourne markets.

Strong investor appetite for the sector, which significantly outweighs supply, has led to a pick-up in yield compression over the second half of 2020 with 26 basis points (bps) of firming recorded. Notably, this compares to 12 bps of firming over the prior six-month period. As at December 2020, the weighted average capitalisation rate (WACR) of the A-REITs industrial assets measured 5.1%, down from 5.5% in December 2019. 

industrial blog chart

From an occupancy perspective, portfolio occupancy for the A-REITs with industrial assets sat at 96.7% in December 2020, slightly down from the 97.0% recorded in June 2020. Our data shows the national industrial vacancy rate currently measures 5.2% (Q4 2020) while the vacancy rate among the A-REITs is lower at 3.3%. Notably, this highlights the lack of leasing options at the institutional end of the market with the bulk of vacancies stemming from secondary grade facilities. 

The H2 2020 results also highlighted institutional demand for consumer staple covenants, particularly food logistics as groups look to build further resiliency into their portfolio. This has seen several groups flag their intention to increase their exposure to certain subsectors such as cold storage. In 2020, we saw almost $2.0 billion in industrial assets sold with a food-based covenant and $694 million in cold storage assets traded over the same period.

With economic conditions expected to improve throughout 2021, supported by further growth in consumer consumption, the trading environment for occupiers is expected to remain strong, particularly those skewed to online retail. However, much still depends on Australia’s ability in maintaining the suppression of COVID-19, although the recent commencement of the vaccine is a positive sign and should flow through to an improvement in consumer sentiment.

Since December 2020, the market has moved quickly with the rate of yield compression picking up in Q1 2021 and is supported by recent sales evidence and current campaigns in the market. In some cases, yield compression of up to 50 basis points has been recorded since the beginning of 2021. The Centuria Industrial REIT’s announcement in late March 2021 highlights this with their weighted average capitalisation rate firming by 46 basis points since December 2020 supporting this.

In combination with new market entrants to the sector, further yield compression is expected in 2021. The equation is simple – demand significantly outstrips the supply of assets and as a result, groups will need to bid aggressively for assets, particularly those with consumer staple covenants.

At present, prime yields as low as 4.00% have been seen in Sydney and we expect there to be instances in 2021 where yields of under 4.00% are struck. In doing so, this would put Sydney and Melbourne broadly in line with other gateway cities around the world where yields as low as 3.5% are recorded.



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Luke Crawford

Director

Research

Sydney CBD

Luke has 10 years’ experience in property research and real estate advisory, providing strategic advice and research to private, government and listed groups. Luke currently heads up the national industrial research function at Colliers International, where he provides high quality research and advice on the trends impacting the sector to both internal business lines and clients.

Prior to joining Colliers International, Luke has held roles within the Real Estate Advisory Services (REAS) division at KPMG and the Research and Consultancy team at Knight Frank.

Luke’s areas of expertise include property research, demographic assessments, highest and best use analysis and supply and demand assessments across a broad range of property sectors including industrial, office, residential, student accommodation and retirement and aged care.

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