C2 Capital The rise of the multi-­let estate

Once seen as the poor cousins to large single-user sheds, multi-let industrial estates are coming into their own and attracting new investors into the sector.

Multi‐let industrial estates aren’t considered the sexiest property sector. Historically, behemoth single-user sheds tended to hog the headlines and the limelight, while the asset management-intensive multi-lets were viewed as their ugly cousin.

How times have changed. The investment market for multi-let industrial estates is now booming. There has been a significant uptick in the volume of these estates being traded, with a growing number of investors – who have never dabbled in this area before – suddenly drawn to the sector.

So why have these estates suddenly become such prized assets and what makes them so attractive to investors?

The growing popularity is down to a number of factors. First, they have a low capital value per square foot, according to Julian Carey, managing director at C2 Capital, which has formed a joint venture with Morgan Stanley called Industrials.co.uk to invest in multi-let industrial estates.

“Typically, you can acquire all but the newest units at less than build cost so new supply would not be able to compete with you, limiting future risk,” says Carey. They also have low obsolescence, he adds. “Refurbishment costs are typically £1/sq ft‐£5/sq ft, which is nominal when compared with offices.”

It is a view shared by Hugh Macdonald-Brown, co‐founder of Roebuck Asset Management, who says that the capital outlay on multi‐let industrial estates is fairly favourable.

“If you buy an office park today, once you start looking under the skin of things you might find the air conditioning needs upgrading and the offices need refurbishing and you, as the landlord, have to foot the bill,” says Macdonald-Brown. “With sheds, tenants tend to be less fussy so they’re much cheaper to refurb.”

They’re also cheaper to build and thanks to their simple design, developers don’t have to take a punt and speculatively build units to secure tenants – they can wait for pre-let or design-and-build deals to come to them.

“The advantage of the industrial market over offices and retail is the speed of construction and delivery to market,” says Simon Lloyd, who leads DTZ’s industrial and logistics team. “You can have a new building up in six months so you can adapt to market demands much more rapidly.”

As a result, investment in this class of property is considered to be much lower on the risk curve than purchasing a larger shed let to a single occupier. That’s because if the occupier goes bust landlords have a major cash‐draining problem on their hands, whereas on a multi-let estate if one tenant goes under you’re still generating income from the other tenants.

“By their multi-let nature they provide a diversified income stream, with little concentration on single-tenant covenant risk, and they provide this at a higher gross rent yield,” explains Shamik Narotam, executive director, real estate investing, at Morgan Stanley. “And this is against a backdrop of recovering regional GDP and limited supply of new space.”

This latter point is reflected in figures from Savills that show average UK-wide vacancy rates of 5.93% for multi‐let estates in 2014 – a significant reduction in available floorspace versus 2009, when average vacancy rates were 9.42%.

The reduction is partly due to the structural shift that has occurred on the high street in recent years, which has had a significant impact on retailers and logistics providers.

“Whereas before the focus for retailers might have been on the high street, now we’re seeing a move towards the internet and that has fuelled demand for small or mid‐sized units on the edge of urban locations, which is where logistics companies need to be based to service these customers,” says Hugh White, head of national investment at BNP Paribas.

Carey says that this shift, coupled with the growing number of SMEs in the UK, has caused demand for multi‐ let industrial estates to rise by around 36% since 2000. This has inevitably had an impact on availability, as has the fact that “supply hasn’t been replenished since the last development cycle”, according to Jody Smith, director at Smith Young Real Estate. “This shortage of stock and increasing occupier demand is pushing up rents, which appeals to investors,” he adds.

Average UK‐wide rents on multi‐let industrial estates have slowly been recovering over the last few years. Data from Savills shows that having fallen at the height of the recession, rents have rebounded to £6.56/sq. ft ‐ in 2007 average rents stood at £6.75/sq. ft. Smith believes there is potential for further rental growth, particularly where industrial land is constrained. “There is always a constant churn of rent reviews on multi‐let estates because of the number of tenants, so there is always an opportunity,” he adds.

Len Rosso, head of industrial and logistics at Colliers, says this growth will inevitably have a knock‐on effect on yields, which, “generally speaking, have eclipsed the last cycle”. Yields in the multi‐let industrial sector are typically in the 8%‐12% range, which is attractive when compared with other sectors. That’s why new investors are being attracted to this sector, says Narotam. “As yields across all asset classes continue compressing, certain investors have gone up the ‘risk curve’ to chase higher yields in more operating-intense asset classes such as multi‐let industrial.”

Multi-let Rents & Vacancy Data 2000 to 2015 image Property Week

Playing the long game

There is another key attraction of multi‐let estates to investors: if they’re prepared to play the long game there is an opportunity to cash in at a later date. Most multi‐let estates are in or near town centres and have strong access links, which makes them good future redevelopment plays.  “They’re often in relatively urban locations so there are always underlying residual land values,” says James Williams, investment director at Savills.

The ability to develop the parcels of land that these multi‐let estates sit on and convert them to higher‐value uses such as retail, trade counters or even residential, is an opportunity that a number of developers have already cottoned on to.

“Anyone who has bought a multi‐let industrial estate in or around London over the past three years had that in their mind,” says Rosso. “The really smart people had that in their minds buying back over the past five to 10 years.”

He adds that the prospect of switching to a more valuable alternative use is now being built into pricing, but the good news for those landlords for whom change of use isn’t an option is that they stand to benefit from this trend either way.

White explains: “It may be that you’re not going to convert your estate to resi, but the likelihood is that others will so you will be left with a rarer product.”

But these products require greater levels of TLC. Multi‐let industrial estates are expensive to manage. Leases are relatively short, which means that there is a lot of occupier churn, requiring a greater intensity of asset management.

They are significantly more asset management-intensive than large-box distribution/logistics sheds and income leakages can be significant when you allow for the additional asset management and recurring re‐ letting/re‐gearing and maintenance costs when compared with large‐box leases, which are often triple net FRI [full repairing and insuring],” says Narotam.

“That is why investors in multi-let industrial, especially those not familiar with the sector, should be very diligent in understanding what is their true recurring cash yield.”

Carey advises that new entrants to the market adopt a “very focused and hands-on approach”. “That’s in addition to capital expenditure, dialogue with tenants and good property management/rent collection,” he explains. “Passive or slow-reacting landlords will struggle to maintain occupancy and grow rents. We regularly see poorly‐managed estates where good estate management could result in immediate gains.”

At the moment, multi-let industrial estates are riding a growth cycle, to the extent that investors who might have traditionally looked at assets stretching into multiple millions of pounds are starting to size up smaller lot sizes because of the intense competition for these chunkier assets.

As the competition heats up this raises the spectre of firms potentially over‐paying to secure lots. Carey, for one, refuses to rule out this scenario. “Hindsight will tell us whether they overpaid, but at present I would say that we need a good few years of strong rental growth in order for some of the acquisitions to deliver upon their forecast returns,” he cautions.

Having said that, Carey believes there is plenty of room for optimism thanks to the current occupier supply/demand dynamic for multi‐let industrial. The sector may not have cast off its ugly cousin mantle just yet, but its growing attraction to investors means it’s well placed to blossom soon.

Article by:  | Property Week
Date:  24th Septemeber 2015
View full article at: www.propertyweek.com