Report indicates continuing positive industrial market

1:15 PM Wednesday March 4, 2015 Colliers Research

Christchurch’s industrial sector goes from strength to strength.

HIGHLIGHTS

Industrial’s golden run continues

Positive signs ahead point to another golden run for the industrial sector, with little signs of a slowdown. Demand is the best it has been in decades and this is an attractive feature for an investment market hungry for good quality investment opportunities. The positive attention the industrial sector is receiving stacks up against a backdrop of strong economic activity. The only foreseeable headwind for further expansion will be access to the type of vacant industrial land that allows development of the premises desired by tenants.

In some areas of New Zealand, particularly in pockets of Auckland where the highest proportion of industrial activity is recorded, this resource is becoming scarce.

Key Findings

  • New Zealand’s economic expansion is fuelling the latest run in the industrial sector’s strong performance. Vacancy rates in Auckland, Wellington and Christchurch have been declining for the last two years. Regional markets are also showing positive signs of leasing activity, but the best sites and premises are receiving most of the attention.
  • Auckland continues to undertake the lion’s share of development activity, however, land supply remains a constraint. For occupational pressure to ease in a market experiencing the strongest demand in two decades, more development is needed.
  • Some landlords may look to reduce incentives and extend lease terms rather than increase rents, but for many tenants rental increases will be inescapable over the next few years.
  • There is more than 3030 hectares of vacant industrial land in the regions of Auckland, Bay of Plenty, Waikato, Wellington, Canterbury and Otago. However, some areas have an oversupply and some an undersupply. Some large tracts of land are unavailable for private development or ownership, or the land is not the right size, shape or contour. This is in some cases restricting the development of modern industrial development that tenants are increasingly demanding.
  • More solid results are expected in 2015 from a sector forging ahead. The need for industrial space will rise in line with economic activity. Tenants should prepare for annual average rent rises between 1.0 per cent and 3.0 per cent and more in the prime sector. Landlords will look to extend lease terms as well. This will stir further positive investment conditions, but only for the right stock which ticks the boxes on covenant, quality, configuration, location and seismic strength.

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MAIN CENTRES

 

Auckland

Demand strongest in two decades

In Auckland, the current vacancy rate is the lowest recorded since our records began in the mid-1990’s, with both prime and secondary vacancy space at all-time lows. Overall the vacancy rate is just 2.9 per cent.

One of the biggest shifts in the Auckland industrial sector in 2014 has been the demand for prime space. The prime vacancy rate was already at a low 3 per cent, but has moved lower to 2.2 per cent.

In some precincts, there is now no prime vacant space available. Much of the current prime vacant space is either recently vacated or remains more difficult to lease due to its location, position, site coverage, layout, configuration or access.

We are at the beginning of a forecast period of economic expansion, which suggests more positive results ahead. There is a lack of options for tenants to choose, signalling the start of a new construction phase in the industrial sector over the short term.

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Construction boost on its way

The ability to construct industrial premises in a shorter time frame than say high rise office towers and their typical occupation by a single tenant, typically reduces mass fluctuations between supply and demand.

However, restricted land availability, rising construction costs and up to four month time delays in materials, such as concrete tilt slabs, are constraining the pace of development activity.

Now that land values are increasing, on the back of a more prosperous environment and rental growth forecasts, new supply will be led by those with the ability to develop their existing land holdings. Much of the focus will remain in the south where land availability is highest.

The structural change in the industrial sector towards distribution and transport is changing the profile of the industrial sector. It is likely that a significant proportion of industrial buildings being constructed in the future will lean towards storage and distribution type premises. This is already noticeable in building consent data.

These developments typically require large parcels of land. Our latest industrial land supply shows that there is a limited amount of supply in some sizes. Approximately half of the vacant industrial land supply in Auckland is in parcels larger than 5 ha, and around half is owned by a handful of owners: the Auckland Airport, Goodman Property Trust, Fletcher Concrete and Construction and Stonehill Trustee Limited.

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Rents rise and incentives reduce

The ability of landlords to increase rents and the ability of tenants to pay them typically follow the fortunes of the economic cycle – a function of the activity levels of tenants producing, moving and selling goods. Therefore, given GDP is forecast to rise by 2.0 per cent to 4.0 per cent pa over the next few years, we expect rents to grow by between 1.0 per cent

and 3 per cent per annum depending on the level of over-renting/under-renting.

Prime quality modern industrial premises will likely see rental

forecasts between 3 per cent and 5 per cent pa The focus on Auckland’s south suggests that is where a lot of this rental growth will be over the next few years.

 

Investment activity still rising

Pent-up investor demand for quality industrial stock is leading to record low yields being achieved on a more regular basis.

Average Auckland regional prime industrial yields will edge slightly lower over the next few years, despite already being at 20-year lows.

The next increase in the interest rate cycle seems to be postponed, which is spurring another round of investment from the owner-occupier market and syndicators.

Land values, which reduced by around 26 per cent after the Global Financial Crisis (GFC) and flat-lined for a sustained period thereafter, are now showing signs of growth: up 7 per cent in the last 12 months.

Many established industrial precincts have land values that are between $300/per square metre pa and $350/per square metre pa for the best sites, if available. Given construction and labour costs are also rising, profitable development of industrial space at high land rates is tenuous.

 

Wellington

Vacancy rate declines further

Rising demand for less available space continues to drive vacancy rates down in the Wellington region. In our latest industrial survey, the most comprehensive available, vacancy has now reached just 5.6 per cent, the lowest recorded since our survey began in 2009. Covering more than 2.5 million square metres of industrial space, only about 143,000 sq m is available to lease. Seaview and Upper Hutt provide just over half of all vacant space.

A number of substantial lease deals were concluded in the past 12 months. One of the largest was Retko Transport that leased almost 11,000 sq m of space at the former Barlow Freight premises at 11 Bell Road South. They join other businesses in the greater Wellington region who have leased space including Mainfreight, Idea Services, Daytona Raceway Go Carts, Laminex, NZ Coach Services, PowerPac, Chemcars, Effuzi and more.

Business Economic Research Limited’s (BERL) forecast of economic expansion of approximately 2 per cent pa in the Wellington region’s industrial sector over the next three years indicates vacancy rates will decline further over the next 12 months. Further upgrades and extensions to major road networks such as Transmission Gully and the Northern Corridor will further boost the industrial sector’s performance and attractiveness.

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First rent rise since GFC and more on the horizon

Higher leasing activity and reducing vacancies are fuelling moderate rental increases. Average gross rents for modern industrial premises typically range between $85 per square metre per annum and $125 per square metre per annum. While this is up only marginally in the last year, it represents the first annual increase in this cycle. Further increases are forecast over the next 12 months reflecting the higher demand environment.

Although rents are lower for older, traditional industrial premises which comprise the majority of Wellington industrial stock, the rise in activity levels is stirring landlords to increase rents across the board.

Further upside for landlords over the past year is the decline in insurance premiums of approximately 10.0 per cent, alleviating some of the pressure arising from gross rents.

Tenants should prepare for rental increases between 1.5 per cent and 3 per cent per annum and a slight reduction in incentives over the next few years.

 

Investment sentiment strong

The positive supply and demand characteristics fuelling rentalincreases has led to increased investment demand as buyersanticipate good medium-term rental growth prospects. The latestColliers International confidence survey shows investors are themost optimistic since the survey began in late 2008.

The sale of therecently developed Masterpet premises to Property for Industry(PFI) reflects this confidence. The property sold for $15.267 millionat a yield of 7.6 per cent. It is one of the largest transactions recordedin the Wellington industrial sector since the sale of the Dunlop/South Pacific Tyres manufacturing complex in Upper Hutt sold for$18.5 million in 2007.

 

Christchurch

Fuelled by the rebuild after the 2010 and 2011 earthquakes, Christchurch’s industrial sector goes from strength to strength.

According to the latest forecasts from Infometrics, GDP in Christchurch city increased by just over 6 per cent in the year ending March 2014.

Expectedly, the construction sector is the biggest beneficiary with growth of more than 15 per cent.

The positive economic expansion is mirrored in the Performance of Manufacturing (PMI) index which monitors production, employment, new orders and finished stocks. A result above 50 is a sign of industry expansion - Canterbury recorded 55.9. One of the most compelling stories is the employment gains in the industrial sector in Canterbury which now has a higher percentage of manufacturing employees than anywhere in New Zealand.

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Construction activity accelerates

Positive underlying economic conditions are boosting tight property market conditions, with vacancies reducing further over 2014.

The latest building consent data shows the response to the demand for properties with more than 700,000m² of building consents issued for storage and factories and industrial buildings since the June quarter in 2011. This three year period between 2011 and 2014 represents 21 per cent of the industrial sector floor space consented since early 1990.

The release of land for further development is well underway with recent sales in Wigram Business Park and Waterloo Business Park receiving steady inquiries with rates ranging between $200 per square metre per annum and $335 per square metre per annum depending on location and size.

 

Investors eye medium term growth prospects

Combined net face rents are now at $120/per square metre pa, with annual appreciation slowing to sub-5.0 per cent compared to 10.0 per cent immediately following the earthquakes. Rents are now more than 28.0 per cent higher than early 2011. Given the demand, rising rents and positive investment conditions; average yields are at 7.8 per cent and 8.9 per cent for prime and secondary premises respectively, with forecasts for further declines over the next 12 months.

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REGIONAL CENTRES

Hamilton

Waikato, supporting a diverse catchment of rural, distribution and storage, construction and manufacturing businesses, has the third highest industrial-related employment and the fourth highest proportion of industrial-related businesses of all 16 regions in New Zealand.

The concentration of services has buoyed the Hamilton industrial market, but tight operating margins continue to restrict the ability of landlords to increase rents above the rate of inflation. While better business conditions are forecast, most of the activity is expected to be recorded in the higher quality end of the market, which continues to receive the most amount of attention from tenants and investors.

Investment yields for prime space will typically range between 7 per cent and 8 per cent given pent-up demand for prime quality stock - a feature dominating most markets in New Zealand.

Owner occupier activity in Hamilton’s industrial market continues to grow as business owners take advantage of the lower interest rate environment and better business conditions.

There is no shortage of industrial land supply in Hamilton with more than 460 ha currently available and more in the pipeline in varying stages and timeframes. There is a future 200 ha to 300 ha potentially available over the next 10 years. Given the restricted design build activity, absorption will remain low over the next few years, which will limit the ability for land value rates to increase. While industrial land values can be as low as $110 per square metre per annum, high demand sites in traditionally sought after locations can exceed $300 per square metre per annum.

 

Tauranga/Mt Maunganui

The positive mood in Tauranga and Mt Maunganui’s industrial sector is understandable given the distribution and storage activity from the port. Steady population growth is also fuelling the construction sector.

While pockets of the market are busier than others, there are still a number of precincts with a relatively steady rental rate environment.

In the wider Bay of Plenty region there are a similar number of employees in transport, postal and warehousing as there is in construction. However, the number of manufacturing employees still represents just below 90 per cent of all industrial-related jobs in the region.

This provides suitable demand for a high proportion of the 1980’s industrial stock prevalent in the area, however, quality, location, access and configuration are still important features of consideration for tenants looking for space.

While industrial land values in the traditional industrial precincts of Tauranga and Mt Maunganui are now reaching in excess of $300 per square metre per annum, options at Tauriko remain at a slight discount. However, the increase in activity as businesses move to the area is starting to place upward pressure on land values.

Cognisant of land value rises and rental rate increases, businesses are looking for owner occupier opportunities. While much of the attention will be focused on Tauriko for now, it is opening up other areas of interest such as Papamoa, which is still a newcomer to the major industrial scene.

Investor activity is upbeat. Pent-up demand for quality industrial stock is keeping yields low - typically ranging between 6.5 per cent and 7.0 per cent for prime stock and 7.5 per cent and 8.5 per cent for secondary stock.

The latest Colliers International investor confidence survey shows a net positive 36 per cent confidence rating in Tauranga and Mt Maunganui, the fourth most optimistic in New Zealand after Auckland, Christchurch and Queenstown. This will buoy investment activity throughout 2015.

 

Dunedin

Investors and tenants continue to be attracted to Dunedin by industrial precincts close to the central business district, ease of road, rail and sea transit options, and attractive property costs when compared with other main centres.

Spurring further positivity is the latest rise in activity, driven by strong business growth and the need to secure more space or upgrade to higher quality buildings. This has led to several industrial occupiers in Dunedin commissioning new design-build premises, but there is also limited prime industrial land available. While in short supply, existing prime premises that provide superior location, efficiency, functionality and seismic strength remain popular among tenants and investors.

Freehold industrial land in Dunedin is scarce, especially in the central industrial precincts, but this shortage will be alleviated in part by Calder Stewart’s development of the former Carisbrook Stadium site. Approximately three hectares of prime freehold industrial-zoned land will be released to the market with strong inquiry for part and full occupation options.

Development of this site will temper demand for other industrial space. However, the stronger demand environment and the pent-up demand for prime investment opportunities are fuelling another round of price escalation. Investment yields remain firm, reaching as low as 7.25 per cent in the inner city, but still more attractive than in many other main industrial precincts in New Zealand. New build premises commanding rents of $115 per square metre per annum are also an indication of the attractive returns on offer in Dunedin.

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Vacant industrial land supply

Vacant industrial land supply in Auckland, Wellington, Canterbury, Waikato, Bay of Plenty and Otago reached 3037 ha as at November 2014 compared to 2709 ha in November 2013.

Vacant industrial land absorption across Auckland was 29 ha in 2014. Approximately 10 ha of vacant industrial land absorption was recorded in South Auckland, where the majority of supply is located.

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Outlook

More solid results are expected in 2015 from a sector forging ahead. With many lead indicators pointing to further economic expansion, this will translate into more production, jobs and the need for industrial space.

This bodes well for industrial areas that have the space to expand, at a reasonable cost, which is increasingly becoming difficult to find in some established precincts. Brownfield development remains a potential route to investigate for some premises reaching the end of their economic life. However, owners are wary of foregoing cash flow and spending money to redevelop premises, especially without tenant pre-commitment.

Another round of rental rate rises is forecast over the next few years. While largely confined to the top end of the sector, forecasts of between 1 per cent and 3.per cent per annum are the likely rates tenants should prepare for at the next rent review. Prime quality, modern premises will attract

higher growth rates. Some landlords of smaller premises will look to extend lease periods to three, four or five years. These terms had reduced significantly between 2008 and 2012.

The investment sector shows no signs of slowing as we close off 2014, and this will carry through into 2015, especially given the extended lower interest rate environment with inflation stuck at the lower end of the RBNZ target band.

While investors are willing to pay a premium for the right stock, they need satisfaction on tenant covenant, construction quality, configuration, location and seismic strength.

 

For more information contact:

 

Alan McMahon

National Director, Research & Consulting

 

Chris Dibble

Auckland Research Manager

 

Nina Zhang

Research Analyst

 

Claire Burns

Research Support

 

Colliers International

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