Rental growth for multilet industrial is cooling but occupier activity remains strong, reports Gerald Eve.
The adviser, in its Multi-let Study revealed exclusively here, finds the sector underpinned by a perfect mix of a lack of supply, a diverse occupier base and a weight of investment capital
After significantly outperforming in 2021, Gerald Eve, which was bought by the US's Newmark earlier this year, says inner London rental growth was still a historically strong 10% in 2022, which was lower than some more fringe and peripheral regions.
Markets outside of the South East have been accelerating, notably in the North West, with double-digit estimated rental value growth in 2022 for the first time on record. While this trend continued into 2023, annualised market rental growth is now slowing to high single digits across the UK.
Multilet void rates continue to increase from recent historic lows, as did the multilet default rate in 2022 at 4.3%, the highest since 2014. That steep rise in the UK company insolvency rate means that Gerald Eve expects multilet defaults to increase again in 2023, though it is likely to remain below what was seen during the financial crisis.
Josh Pater, partner at Gerald Eve, explained that multilet is a fundamentally robust property segment, underpinned by a diverse occupier base and lack of realisable new supply, placing it in a strong position to weather the current economic challenges.
"While inflation rates may be falling, progress has been sluggish and occupier cost pressures have continued to ascend, which include strong passing rental growth while rental reversion is so high. We’ve witnessed the effects of this in logistics assets in the form of reduced take-up and increased sub-letting, which we expect will trickle down into the smaller segment. Having said that, multilet is its own market, with its own unique drivers, and we expect market rental growth to remain positive. As we can see from deals completed by Gerald Eve in the second quarter, rental growth has been helped in part by increased flexibility from landlords.”
On the investment side, Gerald Eve’s research showed that the all-in cost of debt has more than doubled following the dramatic increases in the bank lending rate of SONIA (and its forward curve) after 13 consecutive base rate rises, most recently the 50 basis points increase to 5% in June. Taking the longer term view, Gerald Eve forecasts the industrial sector to resume dominance over other property sectors in 2023-27 but says this will be less emphatic than has been the case, with an average annual total return of 7-8%.
Nick Ogden, partner at Gerald Eve, said: the company continues to be bullish on the industrial sector.
"Concerns around the increasingly hawkish outlook for interest rates have impacted investor sentiment, pushing debt financing out of reach for most across the broader markets. But market trading volumes remain low and prices being paid are relatively strong, having improved through 2023. Low market trading volumes is linked to a lack of investible stock in the market, with a significant weight of money targeting UK commercial property, with industrial still the most prudent option to place capital. While current yields may look low in the context of all-in debt costs, many active investors are buying all-equity and will look beyond current interest rate volatility in anticipation of rates beginning to fall in 2024. In many cases, prices are at or below land plus replacement cost levels, which makes sense on the buy-side longer term.”
The research has extended its energy performance certificates analysis and shows some encouraging signs that landlords are engaging with the minimum energy efficiency standards regulatory deadlines. Around 10% of multi-let floorspace rated C-G was upgraded in 2022. This also appeared to be possible during an ongoing letting, which gives multilet an advantage over other property types. However, a significant proportion upgraded to just meet minimum prevailing regulations, with the most popular improvement outside of the South East to a grade C rating.
Delia Batt, associate in Gerald Eve’s industrial, energy and infrastructure team, said: “With the MEES trajectory set to reach a minimum of ‘C’ by 2027, the clock is ticking. A much more sizeable proportion of industrial stock will be affected by this deadline than the previous one, with 29% of the multilet floorspace in London & the South East rated D and below and 45% in the regions outside. Landlords have made a meaningful start – around 10% of grade D and 20%-30% of the grade E stock were upgraded in 2022, but this will have to accelerate over the coming years if all grade D multilet space is to remain compliant.”
Gerald Eve's multilet research spans 15 years, covering tens of thousands of individual assets, with a sample size in 2022 of 146 million square feet, valued at over £26 billion.