Words by The Industrialist

Savills has released its Shed Briefing: Industrial Spotlight Report for Q1 April 2023, revealing rising industrial rents and a shift in growth for land values on a state-by-state basis.

According to Savills, the industrial market has experienced record rent surges, with rents growing by up to 24% Y/Y while vacancy remains at a historic low. A two-tiered land market is also emerging, as distinctions become apparent at a national and precinct level, with higher rates causing prime yields to rise nationally.

Rental Growth Accelerates: East Coast Rents surge 40% since 2020

After a solid 18 months of unprecedented occupier demand, Savills reports that east coast markets are witnessing a growth rate of more than seven times their 15-year average.

Compared to three years ago, prime rents on the east coast have grown by nearly 40% and secondary rents by 45%, with some sub-markets experiencing growth above 50%, setting new benchmarks. This strong rental growth is enabling owners to capture the upside through market rent reversion and inflation-linked reviews.

Sydney prime net face rents are the highest across the nation reflecting growth of 36.4% over the year, following a 4.4% push in Q1.

Melbourne has been similarly strong, with rents growing on average 16.4% year-on-year and 3.3% growth emerging in Q1.

Brisbane grew 14% year-on-year and 2.8% in Q1, while Perth saw 15.3% average yearly rise and 5.3% in Q1. Adelaide rents rose 9.3% but have stabilised following +5.2% growth in Q3 2022.

“All of Australia’s major cities continue to see industrial rents pushed well above previous benchmarks,” says Katy Dean, National Head of Research at Savills. “Combined with a very high level of demand relative to limited supply, we’re seeing not only record-low vacancy, but also a very high level of pre-commitment.”

Most REITs have reported occupancy rates of 99-100%, says Savills, and an 80%+ commitment rate on new projects. This has started to limit the amount of existing space for lease, with little to no availability for large mandates above 20,000sqm in Sydney and Brisbane. Coupled with the sustained high levels of demand, the sector is under further pressure – with most new supply being pre-committed and build times extending amid rising construction costs.

Ms Dean said that “with all existing space occupied and such strong commitment on new projects, it is hard to see industrial vacancy rates shifting in the short to medium-term.”

Two-Tiered Land Market Emerges as Prime Yields Increase

Savills’ Shed Briefing reveals that growth in industrial land values is at an inflection point, triggered by the rapid rise in rates during the last half of 2022. While markets on the east coast are still showing an average annual growth of rate in the price of small lots of between 16-20%, the pace of this growth has slowed with most showing no change over the last three quarters. According to the Savills report, a two-tiered market dynamic is now apparent, with prices for small lots in some of Sydney sub-markets, which carry an average premium of nearly two times more than Melbourne and Brisbane, began to fall late last year. The pricing shift also reflects what buyers are willing to pay for sites suited to multi-level development, compared to those suited to traditional single level.

Prime yields have also increased nationally in response to higher financing costs, with secondary yields moving at a more gradual pace on the east coast due to reversionary upside. While rent surges have helped to offset yield expansion, Savills say that there has been some repricing in response to higher interest rates and historically higher inflation.

Although the Bid-Ask spread between purchaser and vendor has limited deal activity and caused yields to soften in the second half of 2022 – a trend which has followed into Q1 2023, investment activity could improve amid signs that rates have peaked.

Deal-Making Slows, But Investor Demand Remains Robust

Rising interest rates have slowed the pace of deal-making but investor appetite remains robust and largely unsatiated, says Savills. This is motivated by the strong income potential from the sustained underlying demand for industrial space, amid record low vacancy, a restricted supply pipeline and embedded structural change.

Meanwhile, developers are focusing on building out existing holdings to capture rental growth and support cash flows while expanding their assets under management. With this approach comes a decreasing focus on new land acquisition.

Savills forecasts a shift away from spec projects, with developers expected to turn their focus back toward pre-commitment to mitigate risk and deliver greater certainty to project outcomes.

 

Around Australia: Industrial Yields, Growth & Outlook State by State

New South Wales: Sydney’s Small Lot Values Slip

In Sydney, the annual growth rate of small lots has dipped to 2.3%, compared to its peak of 67% in Q2 2022. Sydney’s prime yields have increased by 25bps quarter-on-quarter, with secondary yields totalling just 12.5bps on average. Except for South Sydney, all precincts recorded a fall in small lot land values in Q1. In blended terms, small lots have declined on average 4.8% quarter-on-quarter.

“Sydney’s industrial land prices have rapidly escalated over the last two years, with the double-digit growth rates reflecting constraints to land supply during a period of historically high occupier demand. Certain pockets have experienced some negative growth – such as the South West and Outer South West corridors, but it’s important to note, these prices are still nearly twice that of two years ago,” said Michael Wall, National Head, Industrial at Savills.

While growth has largely remained on an upward trajectory, with small lot prices growing on average 20% annually over the last three years, and 1-5ha sites averaging c.25% growth, some precincts have clearly reached their inflection point. Rising build prices, combined with higher borrowing costs, saw growth stall from mid-2022 and by Q4. Sydney’s South West and Outer South West precincts have started recording negative growth rates – declining by roughly 20% over the last two quarters.

Victoria: Developers Have Melbourne Fringe in Sights

In Melbourne, small lots land values grew 7.0% year-on-year, down from 44.3% in Q1 2022. Over the last two quarters, there has been a pull back in activity, triggered by the rapid rise in debt costs last year. Warehouse demand is still elevated, with little signs of a meaningful slowdown given vacancy is still near 1.0%.

According to Savills, Melbourne experienced an increase in both prime and secondary yields by 12.5bps quarter-on-quarter. On a blended basis, prime net face rents are up 3.3% quarter-on-quarter (16.4% year-on-year), with secondary up 4.2% quarter-on-quarter and 18.7% on average year-on-year.

“Land rates in Melbourne are showing signs of stabilising after a two year period of heightened competition for developable land, particularly in the West and Northern precincts,”

said Matt Ellis, State Director – Victoria, Industrial at Savills. He went on to state that low supply coupled with high occupier demand have been significant drivers of Melbourne’s land value growth.

“Developer interest in the region has grown, particularly for infill sites, as these present direct access to Melbourne’s relatively dense population centres.”

Queensland: Transport and Logistics Drive New Completions

Brisbane’s small lot land values have currently risen by 18.5% on the same time last year. In Brisbane, prime and secondary market yields have increased an average of 20bps since Q4 2022.

Savills’ report reveals that after surging nearly 60% over the last three years, industrial land price growth has moderated in Brisbane but remain average their five year annual average (12%).

On a blended basis, prime net face rents are up 2.8% quarter-on-quarter and secondary rents are unchanged but up 14.4% year-on-year.

“Rents are expected to keep rising in Brisbane, especially in areas where rents are reset to market rates,” according to Callum Stenson, State Director – Queensland, Industrial at Savills. “And with the vacancy rate averaging 1% or less in some submarkets, there will still be pockets of elevated short-term growth.”

Brisbane’s low vacancy profile and high level of demand has reduced large tenant options (>20,000sqm) and buoyed the current development pipeline. Savills says that new completions could surpass 1 million square metres in 2023, with transport, logistics and retail operations driving a portion of this take-up.

South Australia: Industrial Land Values Skyrocket

Adelaide’s industrial land values are up by 45.1%, while prime and secondary market yields have softened at an average quarterly rate of 25bps.

Savills’ Report reveals that Adelaide’s South West has experienced the largest growth rate of 62.5% year-on-year, an average of $650 per square metre, while the North West also experienced significant growth of 55.6% year-on-year, to an average of $350 per square metre.

Western Australia: Modest Growth Amid Stabilising Build Costs

Perth’s industrial land values are up 13.4%, with the city experiencing a similar softening of prime and secondary market yields at an average 25bps quarterly. On a blended basis, prime net face rents are up 5.3% quarter-on-quarter and 15.2% year-on-year, with secondary rents up 4.1% quarter-on-quarter.

“Although land values have grown over the last year, Perth has lagged that seen on the east coast. With rental growth continuing and vacancy still at record low levels, we believe there is still ground for further gains this year,” said Matthew Hopkins, State Director – WA, Industrial at Savills. “Local developers continue to dominate land acquisition activity.”

Construction costs have begun to stabilise, which Savills asserts will assist in pricing development feasibility over the medium-term. Vacancy is estimated to be less than 1.0% in Perth, and with a limited number of larger prime leasing options, pre-lease enquiry remains elevated to meet demand.

Future Outlook: Global Capital to Increase Exposure to Australia’s Industrial Sector

According to Savills, major institutions have reported their intention to invest more in 2023- 24 than they did in FY22-23, as business confidence inches up despite rising costs.

Savills’ Shed Report has also stated a growing preference for global capital to increase exposure to Australia. This will play a significant role in unlocking greater levels of investment activity within the industrial sector during the second half of 2023.

While further interest rate rises haven’t been ruled out completely, investor sentiment is shifting following recent inflation news and pause in the cycle. Stability in the cycle will give investors confidence and unlock deal activity. There is a significant amount of dry powder looking at industrial and global capital is keen to increase its exposure to Australia.