Share Prices & Company Research

News

03 March 2023

The Industrial and Logistics Sector

In recent years, the industrial and logistics sector in the UK has been growing in importance and gaining increasing popularity among real estate investors. Following Brexit and the pandemic, the extent to which logistics is a critical element of the UK’s infrastructure which underpins the UK’s economic output became increasingly apparent.

Ranging from highly automated large-scale fulfilment centres to small urban or last-journey warehouses, these distribution assets continue to underpin the UK’s economic output by playing an integral role in safeguarding the integrity of supply chains and supporting business functionalities. However, the modern logistics market is still in its relative infancy, with multiple powerful and long-term structural trends underpinning demand for these assets.

A main driver for demand in these assets is related to consumers’ growing demand for flexibility, accessibility, and convenience in retail shopping. This, combined with the decline in the high street and retail footfall, has led to a continued rise in e-commerce in recent years, with online sales accounting for 27% of total retail sales in the first half of 2022.

To fulfil this demand, businesses are having to develop extensive and increasingly complex supply chains, in which logistics real estate plays a fundamental role. Online retail supply chains require more warehouse space than traditional high-street models, with logistical assets playing a crucial role in storing, transporting and delivering online deliveries. Research from Knight Frank and UKWA suggests that every £1bn of additional online sales typically generates between 0.8m and 1.4m sq ft of demand for new logistics property.

Current economic conditions, with high inflation and pressures on consumer finances, are resulting in increased pressure on company margins with the need to not only grow revenue and expand market share, but to optimise supply chains with a focus on resilience, efficiency, and a reduction of costs. With warehouse rents making up a small share of total costs, the consolidation of smaller disparate or retail units into a larger distribution centre will not only offer 9 economies of scale but the ability to optimise staffing and stock levels. This results in the best-located units, which are close to the consumer and in dense urban markets, becoming more important, with such sites offering higher efficiency while also helping to mitigate rising costs associated with labour and transportation.

There is currently a worldwide drive to enhance sustainability performance, with government targets and regulations ensuring the transition of the UK towards net zero by 2050. Consumers are becoming increasingly conscious of the environmental impact of goods they purchase, with organisations under pressure to actively seek warehouses that meet environmental criteria. These modern assets feature enhanced insulation, LED lighting and large roof spaces capable of accommodating solar panels. Grade A buildings are currently the most attractive for occupiers, as they will not require refurbishment to meet the anticipated future regulatory requirements, such as the minimum rating of B for Energy Performance Certificates. Occupiers will place a greater weight on meeting these higher Environmental Social & Governance (ESG) standards that can save costs and reduce the carbon output of warehouse operations.

Supply chains have been the lifelines of globalisation, delivering lower costs and greater efficiencies to the manufacturing sector over previous decades. However, the pandemic, rising geopolitical tensions and a sustainability drive have exposed the limitations of the just-in-time supply model, such as supply chain disruption, and have led companies to prioritise resilience within supply chains. Resilience can be built into supply chains by shifting to a just-in-case inventory management model, which holds more stock, requiring greater warehouse space, to minimise losses if delays in supply do occur. However, concerns around this supply chain disruption have led to some businesses looking to nearshore manufacturing closer to the point of retail. Manufacturers are also under pressure to resolve ESG concerns regarding globalised supply chains, with current production in economies that have lower worker and environmental protections; both factors continue to drive demand for logistical space within the UK.

Despite this strong demand, the supply of these prime, large-scale logistical centres remains constrained. The key component to constructing these assets is the location, with limited land able to accommodate these large buildings, and becoming even more scarce in key locations. ‘Big Boxes’ also require a large local labour pool, with some assets employing more than 3,500 people during peak times. The large scale of these assets requires significant planning permissions, with many requiring rearrangements to traffic routes and, therefore, taking years to obtain the required consents.

Another challenging factor relating to the location of these assets is the availability of and access to power. The supply of energy to sites via the national grid is finite, however, occupiers need to obtain substantial power to meet the future growth of automation and the advancement of electrical transportation. Developers are alive to the issues, with many schemes offering alternative renewable energy provisions and power-saving initiatives to occupiers looking to future-proof their business, with these trends expected to continue through the next few years.

The tight monetary policy experienced in the UK has led to rising interest rates driving up borrowing costs, and inadvertently driving up the ‘all in’ costs of finance for developments. This has also affected the purchasing ability of leveraged buyers, leading to a reduction in the number of speculative builds following the increased risks.

In recent years, there has been a resurgence of occupiers looking to build-to-suit developments that can meet the increasingly bespoke occupier requirements. The economic conditions have led to a reduction in speculative units due to weaker developer risk appetite, following the rising ‘all in’ cost of debt finance, increasing construction costs and higher exit yields which will further impact supply.

The constrained supply and increasing demand have led to an imbalance in the market and have resulted in the vacancy rate within the logistics sector reaching record lows of 2.9% in 2022. The continued demand above long-term averages and vacancy levels remaining critically low with a lack of speculative builds are estimated to lead to continuing rental growth. This growth rate, although expected to be moderate compared to the double-digit growth experienced through 2021 and early 2022, will lead to the logistics sector reinforcing its position as a major contributor to the UK economy, and one of the most attractive locations for favourable returns within real estate investment.
 
This article first appeared in the Winter 2023 issue of the 1875. To subscribe to our investment publications, please visit https://www.redmayne.co.uk/publications.

Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. The value of investments and any income derived from them may go down as well as up and you could get back less than you invested.
 
The Industrial and Logistics Sector
SUBSCRIBE TO OUR PUBLICATIONS
We offer complimentary investment publications produced by our in-house Investment Research team. Please click here to view our range.