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Why 3PLs will never get a five-year lease with a three year break, a years rent free all at a low market rent and why it doesn’t really matter. Liza Helps reports.

This article first appeared in Logistics Manager, November 2017.

Back in 2009, at the height of the recession, occupiers were king, and the deals to be secured on brand new Grade A stock were positively mouth watering. Total availability stood at 15.6 per cent, the amount of modern Grade A space had increased 41 per cent year-on-year to the end of 2008, while the amount of available warehouse space in units over 100,000 sq ft stood at nearly 26 million sq ft.

The spectre of empty rates hung heavily in the air, and the market looked like it was going nowhere fast. In the North West alone, year-on-year like-for-like requirements for buildings over 100,000 sq ft were down 30 per cent. And it was a similar story for smaller requirements as well.

Research by Savills at the time predicted a further 34 per cent fall in demand across the market as a whole, as retail spend retreated dramatically.

Prologis had 16 empty speculative buildings round the UK. The battle was on to get them let and secure an income stream going forward in an extremely competitive market.

Never one to shy from a challenge, the company pulled out all the stops. It was extremely successful in letting all 16 units within a couple of years. It managed that by offering occupiers deals too good to be missed. Initiatives included offering leases from three years, with six-monthly break clauses thereafter, across the whole of its five million sq ft portfolio in the UK.

Alan Sarjant of Prologis said at the time that the primary task was to get the stock income producing. He said that the developer was willing to take a longer-term view on incentives, such as generic fit-out, as this would enhance the marketability of the stock in the long term. To this end the developer did not look to amortise the full cost of the fit-out over the length of a short-term lease, although a proportion of the cost was annualised and paid as part of the rent. The generic fit out included sprinklers, heating and lighting.

It was not the only landlord to be so proactive; Standard Life Investments offered a range of incentives, with the aim of fully letting its Suttons Business Park near Reading. That included the payment of all or part of a new tenant’s dilapidations costs on its previous premises, or fit-out of its new space at Suttons. In addition, existing tenants also benefited from a rent-free period for introducing a new tenant.

At the time it was said that many landlords/developers were doing deals purely for cash flow with often many below cost to avoid paying empty rates.
Occupiers never had it so good.

Push on eight years or so and the market is very different. Stock availability is at an all time low, vacancy rates at an all time high, and demand despite Brexit continuing steady.
The reason for this says Bob Nicholson, development director at DBS Pochin, is the internet.

“The internet has played a major part in the development of industrial space in recent years. The rise of e-commerce, in particular, has increased the demand for industrial facilities, with logistics companies and operations teams playing an ever more crucial role in the running of these businesses. Meeting the demand of the logistics sector requires flexibility; as well as large units for storing huge amounts of stock, retailers and delivery companies need smaller distribution centres for the rapid, short-range delivery needed to meet their same-day and ‘click and collect’ offerings. This level of occupier demand has led to the increasing development of bespoke facilities, made to measure, and the development of speculative industrial units that are built with this flexibility in mind. We know that for every 1 billion euros spent online, an additional 775,000 sq ft of warehousing space is required, so that trend isn’t likely to change.”

Indeed growth in online shopping is set to increase by more than £30 billion through to 2020. Online retail sales in the UK topped £133 billion in 2016 alone, beating expectations with a 16 per cent jump from 2015, according to the e-Retail Sales Index from Capgemini and IMRG.

Sales have grown 16.4 per cent year-on-year to August 2017. Effectively that means a further 16 million sq ft of space is required just to serve the e-commerce market.
Jonathan Compton of CBRE says: “In 2012 take up of units over 100,000 sq ft by on-line retailing made up 0.6 per cent of the market it now stands at 33 per cent.”

According to Len Rosso of Colliers, at present the UK’s supply strategy lacks the foresight to accommodate demand. “After record demand in 2016, in the first half of 2017 there was 6.8 million sq ft of take-up of units larger than 250,000 sq ft. This equates to 28 per cent above the ten-year average and 8 per cent above the five-year average.
“Such is the demand that, at present, the UK has little under one year’s worth of industrial space left as the growth in e-commerce and a renewed demand for British goods places even greater pressure on the country’s industrial stock.

“The availability of big sheds (units of more than 100,000 sq ft) has fallen by 72 per cent since 2010, with only 2.8 million sq ft of new or refurbished ‘ready-to-occupy’ space available in the UK.
“Although we are seeing more ‘design and build’ in the industrial market, particularly in areas with low availability, there is just 17 million sq ft of industrial space under construction.”

With such a demand and supply imbalance, one would think that developers and landlords would be building more. Many are, but on a completely different scale than previously. Daniel Burn of dbSymmetry explains: “Investors are being a lot more prudent, appraisals are harder and more guarantees are required. Gone are the days of building something out on the back of a fag packet; a lot more research and a lot more thought goes in to developing speculative product now.”

The industry has come a long way from a situation in the nineties where the units were smaller and 25-year leases were the norm. By the early noughties the market picked up on the back of the easy to get finance, a supermarket/retail boom; buildings got bigger and leases got a lot shorter.

By 2006/7 the market was booming, investors were piling in and speculative development was the fastest way to get a slice of the action. Then the crash happened, and suddenly there were a lot of speculative buildings left hanging in the market, landlords were desperate to get their cash back and prepared to take short-term leases and offer enormous incentives so that headline rents could remain high and book values maintained. Speculative development dried up over night.

That notwithstanding there has been a renaissance in the logistics market, and there is a huge weight of money wishing to take advantage of the new boom.

But says Burn, “major institutional funds were stung previously, some have not returned and those that have are a lot more cautious in their approach.”

There has been a stronger focus on prime locations, and where once developers would build a cluster of speculative developments, now it is more likely that only one or two buildings will be built speculatively with no more being built until those are let.

Compton says: “There is still a risk building speculatively with funding borrowed against building. A lot will be geared against a covenant and the type of lease in place; then there are empty rates if you cannot let the property quickly. These are unrecoverable costs.”

Many developers prefer to wait for a pre-let on a site before embarking or even considering speculative development. For others having a big site, where there is the ability to draw in a large pre-let, dilutes the risk so building out a relatively small speculative warehouse to garner interest is perceived as acceptable risk.
In the majority of cases these speculative buildings let before practical completion, or within a year of construction at the latest. UK Mail took a unit at IDI Gazeley’s Magna Park Milton Keynes before practical completion.

Similarly, Amazon snapped up a warehouse at Goodman’s Northampton Commercial Park.

That is not to say that developers are not building speculatively; they are, but judiciously.

dbSymmetry is speculatively building a variety of units tapping into a what it perceives is a gap in the market for regional development. In the North West it is speculatively developing a 160,000 sq ft facility at Ma6nitude in Middlewich with joint venture partner Pochin.

Ma6nitude formerly known as Midpoint18 totals 450 acres and occupiers already located at the site include B&M Bargains, Kuehne + Nagel, and Wincanton.
The speculative warehouse is to be the first building started since the JV was agreed between DB Symmetry and Pochin in October 2016, and is expected to be ready for occupation in 2018.
It forms part of the first of three phases that will see Ma6nitude built out in full; a project expected to deliver a further nine industrial and distribution facilities across 1,750,000 sq ft.

The 160,400 sq ft unit will boast 12.5m eaves, a 50m deep yard, as well as five per cent fully fitted offices and generous car parking. Letting agents are B8 Real Estate, Savills and Legat Owen.
dbSymmetry is also developing in Swindon, Bicester and Doncaster. Unit 1 at Symmetry Park Swindon will total 217,323 sq ft and will have 12m eaves, a 50m yard, 20 dock and four level access doors, as well as 35 HGV and 203 car parking spaces. It is expected to be ready for occupation in January 2018. Letting agents are Savills, Whitmarsh Lockhart and Colliers.

The largest speculative development is IDI Gazeley’s 574,000 sq ft mega shed, Altitude, at its Magna Park Milton Keynes development. The new development has been touted as the largest speculatively built shed since the financial crisis in 2008. Construction is underway and is expected to complete in February 2018.
The building, on a 26.26 acre plot, will have 532,560 sq ft of warehousing space, 26,802 sq ft of offices, as well as two office pods to the north and south of the building , each totalling 7,233 sq ft. In addition it will have 100 HGV and 381 car parking spaces as well as a 21m haunch height, 117 dock and eight level access doors. Letting agents are JLL and Savills.
Despite this being considered an exceptionally risky move, Bruce Topley of IDI Gazeley says: “We have looked at all the 500,000 sq ft plus buildings built in the UK in the last four years: loading, position of doors, yard depth, height, configuration and we have looked at what has been delivered in each of those measures and have come up with Altitude. We consider this an informed build – building speculatively but in an informed way.”

With supply constrained it is not surprising, says David Binks of Cushman & Wakefield, that “landlords have had the upper hand”.
“It is much harder for occupiers to get a great deal; lease lengths are hardening and rents are rising.”

However saying that, lease terms are certainly more flexible and lease lengths shorter than they were 20 years ago. In the 90s a 20 – 25 year term was considered the norm. Nowadays, occupiers face lease terms of 10 – 15 years on a design and build option, or 10 years for an existing building in general terms.
Some developers and investors may look at shorter and more flexible lease terms. Oliver Treneman of DP World says: “We take an extremely flexible approach to leasing recognising that the 3PLs are locked into five year contracts in general – sometimes more sometimes less – and it is essential for them to have flexibility. We try to look at a business case with that in mind acknowledging that 3PLs make substantial capital investment their buildings. We take a pragmatic view that their interest and ours are aligned.”

It helps that the funding for the development comes from Dubai, and that the company keeps its investment in the long term, whilst being free of medium term return constraints.
That being said Treneman says: “All common sense due diligence pieces all apply – you need a creditworthy customer.”
It is thought that DPWorld and joint venture partner Prologis have secured a five year lease on their 316,000 sq ft speculative warehouse, with a letting to Dixons Carphone Warehouse – which just proves the point.

DP World is currently progressing with its London Gateway Port, which can provide up to 9.25 million sq ft of associated warehouse space. A local development planning order across the site means that buildings can be fast tracked, removing all risk and uncertainty about timing of commencement of construction.
According to Paul Weston of Prologis, the developer is not averse to looking at short term leases. “As a business we are not averse to a five year lease.

“An institutional investor may be holding out for a minimum 10 year terms but a lot of it comes down to appraisals and stacking up the deal financially. The market is hot for this product at the moment and that plays into the occupier’s favour.”
Indeed Rosso says: “Yields have compressed so much that you have got the scenario that in a prime location with a good quality tenant with a five to seven year lease term selling for the same yield as a ten year term two or three years ago.

“From an occupier’s perspective the landlord may be able to get it to work on a shorter lease. A lot more funds will consider a short lease a few years ago perhaps five per cent now up to 30 per cent will look at a shorter one. If you don’t ask you won’t get.”
For many landlords and investors the opportunity to asset manage within their portfolios is very attractive especially in a rising market.
An occupier could also ask for a break in the lease, Robert Rae of Avison Young notes: “Generally we are seeing tenants requesting breaks in line with contracts particularly 3PLs but where there is a shortage of stock investors/landlords are seeking ten-year leases occasionally with a break being given on a new building at 7.5 or eight years subject to penalties.”
Treneman says it is worth offering breaks: “What we have found is that those taking short term leases in say 2009 and 2010, 75 per cent are still in the same building. Is that not proof of concept that what is good in Europe [with 3,6 and 9 year leases]can also be good in the UK?”

Ross agrees: “Broadly speaking 70 per cent of those on short leases or with breaks remain.”
Mike Hughes CEO of Verdion says: “If 3PLs want a shorter lease they very often don’t understand there is a compensation requirement. As a business we need to make a return on investment. “But its not just about lease length its about the total lease package on offer.”
For him this includes the ability to provide occupiers with the facilities they need designed, built and delivered in a timely fashion getting what they want without compromise.
“It’s a competitive market place increasingly demanding and sophisticated. Developers need to have an in depth knowledge of the client and if you do not have the organisational structure that shows proven ability that will put you at severe disadvantage and woe betide any organisation that might let down a major internet retailer or 3PL – you will not be doing business with them again.”

There is a lot of investment and time that goes into delivering schemes such as iPort. Hughes started to personally assemble the site back in 2002, and had to gain both public and political support for the £500 million project.

The project in the end has involved the development of a Strategic Rail Freight Interchange, the development of the £55 million Great Yorkshire Way road linking the site to Junction 3 of he M18 motorway and the development of a logistics warehouse scheme that could accommodate up to 6 million sq ft of space.
“There was 18 months of groundwork to put the infrastructure in place before we could press the button to build the buildings and there were so many things that could have tripped us up; from the power requirement issue, to the issue of connecting the railway, environmental issues and so many third parties to persuade, align and cooperate with that you could fill a concert hall full of them”

Since then the scheme has been a phenomenal success, but Hughes says when he originally went out to secure backing it was quite different story. In the end Verdion entered into an agreement with Canadian pension fund, Healthcare of Ontario Pension Plan (HOOPP) in 2013.

In 2016 alone the scheme secured lettings with Amazon, Fellowes, CEVA and Lidl totalling 2.34 million. Earlier this year it launched the second phase of he scheme and is due to launch iPort rail in 2018, along with more speculative development. Gent Visick, CBRE and Cushman & Wakefield are letting agents for iPort.

Gareth Osborn of SEGRO says: “In general terms, conditions and rents are moving upwards with incentives getting tighter but there is still a degree of flexibility.
“Of course any developer/landlord confronted with two proposals will go for the one offering a longer lease but if people are prepared to pay the price in flexibility in terms of rent and incentive levels, there is room for manoeuvre.”

He says occupiers can also look at second hand stock .
Burn says: “We are seeing more 3Pls considering sharer-user style facilities putting two or three contracts together rather than being reliant on one for the building.”
It is certainly worth considering as Compton says: “We are really at a point in the market when the movement of technology is taking us into the unknown. How will the supply chain change in next ten years?”

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