Melbourne Industrial Report 2016

MELBOURNE INDUSTRIAL MARKET

The recent pick-up in demand for industrial space is a reflection of the strength of the Victorian economy, which is leading all states and territories in terms of State Final Demand growth. Indeed, industrial demand indicators for warehouse space has reached its highest level since 2005.

Leasing Market

Demand for industrial property has picked up pace strongly over the last 12 months with gross and net take-up of space well above the long run average-buoyed by increased activity in the pre-lease market.

The Bulk of demand is being generated from retailers as well as transport and logistics operators, who are investing in new facilities to increase efficiency in their supply chains and distribution networks.

Tenant demand is being encouraged by favourable leasing deals which allow companies to move into new, more efficient premises at little to no rent premium. Most of the take-up of space has been concentrated in the West and the South-East, with much lower demand in the North and City-Fringe.

At the smaller end of the market, agents report good enquiry from owner occupiers across the regions, with many looking to take advantage of low interest rates to secure their own premises.

Over the last 12 months, prime net stated rents have remained stable across all the regions, ranging from an average $74 per square metre in the West up to $82 in the South-East. At the same time, City-Fringe rents increased by about 4% to an average $144 per square metre underpinned by rising land values in the wake of recent rezoning’s. In the secondary market, rents remained stable across the regions, with the benchmark South-East sitting at an average $62 per square metre.

Surprisingly, rents have remained steady even in the face of rising vacancies. The reason is that face rents are being supported by substantial leasing incentives. The strength of the investment market and subsequent firming yields/rising values has allowed the major owners to compete hard for tenants, offering substantial lease incentives and placing a floor under stated rents.

Leasing outlook

Demand for industrial property in Melbourne will be heavily influenced by the outlook for the Victorian and national economies and is unlikely to maintain the same momentum of the last 12 months. Demand for warehousing is expected to soften in the next two years as growth in Victorian economy weakens.

The positives for the Victorian economy are expected to come from rising public investment-as several infrastructure projects proceed-and private consumption expenditure, flowing from the strength in the labour market, which is expected to be maintained for at least the next 12 months. Major projects set to commence in the short term include the $.5. billion Western Distributor Upgrade and Metro Rail.

Even so, the Victorian economy faces several headwinds. Victoria is a net exporter of goods and services to other states and will be affected by sluggish national growth as the negative shock from the resources downturn is absorbed and non-mining business investment takes time to recover. Lower economic growth will lead to lower demand for goods to be stored and distributed and reduce demand for new warehouses.

Supporting tenant demand is the continued search for larger and more efficient warehouses, or “upgrader demand”. This demand is more difficult to determine, but it is only likely to maintain momentum while the investment market allows for attractive pre-lease deals.

The outlook for average net stated rents across Melbourne will be influenced by continued strong competition in the pre-lease market weakening demand and rising vacancies, over the next three years to June 2019, we forecast rent growth across the regions of 2% to 5%. Increasing competition to attract tenants to the secondary market will also weigh on rents, with minimal growth forecast in the South-East. The nudging-up of leasing incentives is expected to see both prime and secondary effective rents in the South-East decline by about 3% over the next two years before stabilising.

Investment Market

The investment market has been very buoyant in Melbourne with the value of deals reaching their highest levels since 2007. The world-wide “hunt for yield” means investors are attracted to the stable cashflow offered by industrial properties and comparably attractive yields on offer.

Over the last 12 months a number of benchmark sales have occurred in Melbourne, including Charter Hall’s $238 million purchase of Woolworths, yet-to-be-built 69,000 square metre distribution centre at Dandenong, and a number of portfolio sales. Unlisted funs and foreign investors are the most aggressive in chasing assets. Solid demand from owner-occupiers and developers across most of the regions is also driving sales activity in the sub-5,000 square metre market.

Prime yields have firmed by around 40 basis points, underpinning solid price growth. Indeed, prime yields in the West, South-East and City-Fringe are now below the rates reached in 2007. The firming in secondary yields has been at a slower pace, at around 20 basis points, trailing their 2007 lows by 50 to 80 basis points. As a result, price growth is more moderate.

Investment outlook

We expect the flow of funds into the industrial property markets will push prime yields a little lower before stabilising. We forecast a further firming of 25 basis points across the regions by June 2017, to an average of around 6.5%.

Prospects for capital growth amongst prime industrial property remain reasonable over the next 12 months as the firming in yields continues. Subsequently, prices are expected to stabilise. Secondary prices will follow the same pattern, but display weaker growth with investors continuing to favour prime assets.

Supply

The value of industrial construction in Melbourne has climbed close to the record levels last seen between 2005 and 2008. Over the year to June 2016, we estimate that the value of work done for warehouses and factories reached $1 billion, 80% of which is warehouses.

Most activity has been focused in the South-East and West. Estimates suggest between 600,000 and 700,000 square metres of supply is underway, which is well above the long run average. Major projects underway include CEVA’S 90,000 square metre distribution centre at Truganina, Target’s 63,000 square metre facility, also at Truganina, and Woolworths’ 69,000 square metre warehouse at Dandenong.

Major developers are aggressively competing for tenants, encouraging businesses to upgrade/consolidate into new premises at little to no price premium before selling the asset into their own managed fund or to other investors. Major investors including Frasers and Goodman are also rolling out several speculative projects in an attempt to secure businesses who need new space within a limited period of time.

Agents/major developers report an emerging shortage of serviced retail lots in the West as well as localised shortages in the North, around Epping, and in the South-East around Keysborough/Dandenong flowing through to rising land values. Strong demand is coming from owner occupiers and private developers. However, these shortages are yet to have a material impact on rents.

Supply outlook

Based on the number of buildings underway and the latest approvals data, the value of construction work done is expected to remain high over the next 12 to 18 months with warehouses dominating new supply. Apart from the major pre-leases mentioned above, there are numerous projects exceeding 20,000 square metres that are underway or about to proceed which will help underpin activity. Supply will remain focused on the West and South-East.