Will the brakes go on warehouse development in 2023?

Brexit and Covid-19 have had huge impacts on demand for warehousing in the UK, the evidence being clear from the number of large sheds springing up alongside major motorways. MT spoke to three experts in the field of logistics property development to get their views on prospects for 2023.

Charles Binks, UK logistics team department head at leading global property advisor Knight Frank, says it is difficult to separate the effects of Brexit and the pandemic.

“Covid-19 had a massive impact, accelerating the online side, so demand went through the roof,” he says. “In 2019 take-up of warehouses over 50,000sq ft was about 35m sq ft. This rose to 50m sq ft in 2020 and 70m-plus in 2021. Take up in the first three quarters of 2022 was 37.2m sq ft so the market is still pretty buoyant but those figures will be significantly lower in 2023.

“This will be driven by lack of supply and more recently by economic and geopolitical issues. A lot of the online players have been a lot quieter in 2022 whereas during the pandemic they were taking space like it was going out of fashion. If they had space it meant they could get product into the warehouse and they could sell it.”

Greg Cooper (pictured) leads the UK logistics team at leading logistics property developer Hines. He believes that the Brexit effect is still being felt though Covid-19 accelerated the trend.

“Since Brexit we have seen a steady increase in take up of warehouse and industrial space,” he says. “It reached its pinnacle as we came through the pandemic which saw an acceleration of the change in the retailscape and the shift towards spend online.

“That reached its high point during Covid-19 and drove a lot of retailers to accelerate plans to restructure their supply chains and have more warehouse space. Since Brexit there has been more inventory build up and that has contributed to the surge in demand.”

This meant some ecommerce firms have had to compromise on the location of sites.

“For the first time in my career companies were saying ‘ideally I want to be in the North West but I can’t find a building so I will go into Yorkshire or the Midlands’,” says Binks. “After Brexit, the Dutch were inundated with requirements from UK companies wanting to set up facilities in Europe and likewise there were European businesses wanting a foothold over here.

“The other thing I hear from my clients is that the labour force was good but now they are struggling to recruit. The mythical British workforce ready to step into the breach doesn’t seem to be too visible.”

Buildings used for medium to long term storage and distribution are often different from a fast-moving ecommerce operation.

“For ecomm it has been either the big very automated fulfilment centres or its been last mile delivery,” says Binks. “For others it is about near-shoring and holding more inventory to deal with Covid lockdowns and ships getting stuck in the Suez Canal. People realised that global supply chains aren’t necessarily that resilient and it doesn’t take much to knock them off out of line. It then doesn’t take long, when you’re dealing with just-in-time supplies, to have an impact at the consumer end.”

Demand to slow

After the logistics sector coped with unprecedented volumes in the last four years Binks says demand looks like it will ease off in 2023.

“The 3PLs have never been so busy, first with PPE and then companies holding more stock,” he says. “We are just starting to see more flexibility in their networks through PPE being destroyed because it is not economic to keep storing it for years.

“The market has been super-charged and is now dropping back to a good level of activity. We are still seeing rental growth in some areas where supply is at an all-time low and space which was planned is no longer being built because debt levels and interest rate hikes no longer make it viable.

“But space is starting to come back through consolidation and business failures. It is an interesting dynamic.”

A recent revaluation of commercial property for setting business rates saw warehousing values rise by over 27% on average which will feed through into higher rates for occupiers in 2023.

Claire Williams (pictured), head of research in Knight Frank’s logistics team, says that had been a rebalancing of rateable values between retail property and warehousing.

“Retail has benefitted from the revaluation whereas logistics is going to be quite hard hit,” she says. “They will be penalised more than other sectors.”

This could limit further rises in rent charged on warehousing as higher rates will affect tenants’ ability to pay.

“What occupiers will look at is their total cost of occupation, including rent, rates electricity etc,” says Binks. “If rates and power bills are going up dramatically it will affect their ability to keep paying higher rents in 2023 and that, along with other factors, may slow rental growth.”

There is still some debate about how the higher rates will be introduced and Cooper says warehousing tenants will be arguing strongly for transitional relief.

“Occupiers are going to have loud voices to make sure they are getting assistance in the transition,” he says. “Right now the business rates for logistics and warehouse operators will be going up to varying degrees across the country and that will have an impact on occupational costs.”

No vacancies

But rental growth will only slow or reverse when supply and demand come back into line, and at the end of 2022 space was still at a premium.

“There are very low vacancy rates,” says Williams. “At the end of Q3 2022 vacancies were 3.1% across the UK in units over 50,000sq ft. That was the lowest on record.

“There is more space coming through the pipeline but development has been curtailed by rising build and borrowing costs.”

Binks expects vacancies to increase in 2023 as the UK economy starts to slow.

“Vacancies need to increase from those sorts of levels,” he says. “In some markets there is next to nothing available and that is not good. We need vacancies to allow people to move around. We won’t end up like we did after the financial crisis of 2007/08 when there was 30m sq ft of brand new space available.”

Cooper agrees that vacancy rates are at “historic lows” and he doesn’t expect any rapid increase in 2023.

“Vacancies are hovering at just below 4% and lots of broker houses cite anything below 12% as an efficient market in terms of rental growth,” he says. “We are still very much in a low supply market and when we went into the global financial crisis vacancy rates were 25%.

"Looking forward to 2023 there is still an amount of spec space [in units over 100,000sq ft] pushing 20m sq ft coming to the market but that is against the take up in 2021 of 50m sq ft and in 2022 it looks like we will do 40m or 45m sq ft.

“I certainly don’t think we are going to swing to a glut of supply in 2023.”

Demand will also be shored up by other users of industrial and logistics space such as data centres and manufacturers competing for large sheds.

Spec development

The spike in demand for warehousing in the pandemic drove a similar surge in speculative development as yields (the rental value as a percentage of market value) went out to 5% or above. A recession could however abruptly turn off this pipeline of spec space built without an occupier lined up.

“There was a lot of building at risk and putting a generic product out into the market,” says Binks (pictured). “People have been spec building units up to 600,000sq ft and being very successful with them. With the hike in interest rates yields have increased by 200 basis points and something that was attracting 3% might now be getting over 5%.

“We saw over the pandemic massive increases in land costs and if you need debt that will have an impact. There are still schemes being delivered on a speculative basis and that will continue but the level of space being delivered into the market will fall back. We have clients saying ‘we could do with a pre-let rather than building this speculatively to make this stack up’.

“The rents are already pretty high so they can’t look at increasing them any more, build costs are going north and if they have already bought the land they have no wriggle room.”

This could see spec development dry up in less popular parts of the UK.

“Their expectations of capital value and rental growth for the whole period of ownership have been revised down and that will further dampen what they are willing to pay,” adds Williams. “Weaker secondary locations are now more likely to fall below the development viability threshold.”

The so-called ‘golden triangle’ in the Midlands is still the logistics’ industry hot spot for large national DCs and despite rising costs this will remain true in 2023, says Cooper.

“The golden triangle tends to be the centre of gravity for the UK,” he says. “That is predicated on how much of the UK population can be reached in a four-and-half-hour drive time. However there are other variables at play, the cost and availability of labour definitely being one. That is forcing some occupiers to consider what would otherwise have been deemed slightly peripheral locations.”

Lease flexibility

Economic uncertainty in the coming two years also means some occupiers are looking for more flexibility in terms of leases.

“Of late the most common lease term we have been asked to consider is 10 years,” says Cooper. “That is driven by the cap-ex for fit out that needs to be pushed into a building by an occupier - the more cap-ex often the longer the lease term the occupier wants to amortise that cost. It has also been driven by supply and demand and occupiers wanting protection of their strategic foothold in a particular market that they are committing to.

“However in recent months we are seeing more requests for slightly more flexible lease terms. That is something we are definitely willing to consider but often the quid pro quo may be that flexibility comes at a premium rent or the ability to review the rent more regularly than the traditional five year review cycle.”

Warehouses have continued to get larger over time and 250,000sq ft is no longer considered exceptional.

“During the pandemic when ecommerce was driving the market the average size of units was increasing,” says Binks. “You were looking at the 300,000sq ft to 400,000sq ft bracket and there was a lot of space of that size being built. Now there are a lot more in the 150,000sq ft to 250,000sq ft bracket.”

Cooper says that a typical warehouse designed for a 3PL ‘big box’ operation in the golden triangle would be between 200,000sq ft and 400,000sq ft.

“That is probably the range most developers would look at,” he says. “But it really is market dependent. We are currently on site building seven spec developments and they range from 75,000sq ft to 350,000sq ft. We try to cater to the demand in any localised market.”

Single occupier

Despite their size, most developments are still intended for single rather than shared occupation.

“We have never been able to get our head around the European concept of the halls and having a 500,000sq ft building that can be divided into five self-contained units,” says Binks. “People still like single occupation with their own yard etc.”

Occupiers of spec built warehouses sometimes complain that the developer has maximised the square footage of the building because that is what the rent is based on, leaving inadequate space for vehicles to manoeuvre and park.

“Most developers now build a pretty good product,” says Binks. “But it is true that if the parking doesn’t work the building doesn’t work. The standard development will have a 50m yard so you can get vehicles on to docks and park up trailers.

“Yes there will be occasions where the developer is trying to squeeze the last square foot out of a site and occasionally you might get them with 40m or 45m yards which is a bit tight. If someone has a very large fleet they need to park they would probably look at the design and build route.”

Cooper concedes that spec buildings are not always ideal for operators wanting large yards.

“We are always trying to cater to the widest possible occupier base that we can,” he says. “We always try to deliver something that could suit everyone so we are never going to get it quite right.

“Parking for HGVs and cars is often a bone of contention and we have to make our development as efficient as we can. The rents are usually only paid on the building and to make a development viable we have to build to a certain site coverage. That is potentially slightly different from what operators want.”

Height and power

Building heights have also increased as warehouse equipment has improved and automation becomes more affordable.

“On bigger units now we are looking at minimum height of 15m with some at 18m,” says Binks. “On design and build it could well be into the 20s. The bare minimum on a big warehouse would be 12m and most of the product over 250,000sq ft being put into the market is being delivered with a minimum height of 15m.”

While the National Grid is urging transport operators to consider the size of the local electricity grid connection when siting distribution centres as the future of transport fleets will be electric in some form, very few occupiers are yet putting that at the top of their wish list.

“Yes power is a major consideration but it is not necessarily for the electrification of vehicles,” says Binks. “It is more for automation and mechanisation within the warehouse. In the last mile sector there is more need for vehicle charging but no one is looking to charge a fleet of electric HGVs.

“These buildings are very power hungry and if occupiers have a gripe about developers it is probably that they deliver these building with inadequate power supplies.”

Power considerations are pushing operators into locations that would otherwise have been seen as less than ideal.

“Some occupiers, especially where their warehousing space is highly automated, are having to consider maybe peripheral locations if the power is available,” says Cooper. “Occupiers are looking at how they can make their buildings more sustainable and as landlords we are very keen to see our real estate portfolio reduce its carbon footprint.

“We are working in step with occupiers to achieve that with upgrades to the buildings such as photo voltaic panels on roofs and electric vehicle charging points in yards and carparks.”