Given that it’s been the flavour-of-the-month for a few years now, asking whether industrials can continue to rise is a loaded question.

Before posing key questions to industry experts, Trent Cropley (TC) senior director JLL provided delegates at this year’s NPC with some historical context as to when and why the landscape for industrials really changed: This is what he said:

Huge supply chain disruptions, both domestically and internationally, during the pandemic saw international shipping groups stop their fleets on the expectation that everything would come to a grinding halt. But while everyone was unable to travel too far from their homes – there was huge demand – and the problem was that there wasn’t the ability to service that big surge in demand.

A lot of the shipping companies benefitted from a bidding war from businesses trying to get containers onto ships.

Anecdotally, one of my clients recalls the cost of a 20 ft equivalent unit container, fully loaded from China to the east coast of Australia went from $350/ pre-pandemic to between $7,500 to $9,500 at the peak.

This had a knock-on effect on the industrial market and the occupiers through the supply chain disruption, with a typical 30-day window for delivery blowing out to three to four months or more.

A lot of these occupiers decided that instead of buying for example 10,000 units of product, they would order 50,000 – so that when the orders came through they could service their retail requirements.

This became a big driver of occupier demand in all states of Australia through the pandemic and it became quite a defensive asset class. So industrial benefitted from all of that and it really super-charged online retailing.

TC: So that said, where are we now with the next phase of the investment piece for industrials?

Vanessa Rader (VR) Ray White Corporate:

It’s been an interesting time since interest rates started moving upward.

During the pandemic, we saw investors of all shapes, sizes and values jump into the commercial property space as an asset class and industrials were definitely top of their list.

With interest rates going up, we saw an immediate retraction in people wanting to invest, with uncertainty around the cost of finance being the major driver.

But during this time, industrials continued to trickle along in terms of rental growth and transaction activity.

Fast forward to today, and there’s been some stability in the interest rate position. I think we’ve seen a lot of people feeling more confident to get back into commercial property investment and industrials still remains that number one choice.

The demand is still there and there hasn’t been a huge amount of supply. The cost of entry into industrials can vary widely from a small occupier of an industrial unit through to a large institutional-owned shed, so it’s an attractive investment piece for a lot of investor types.

Meanwhile, rents which grew so dramatically, continue growing, albeit not at the same levels, and this gives a lot of certainty and confidence, and what I’m seeing now is this investment piece continue.

TC: What do you think, Greg, on the investment side of things? We talked about 400bps increases in the cash rate, naturally that trickled through to the debt market, how are you seeing that specifically through the Sydney REITs?

Greg Preston (GP) chairman of Preston Rowe Paterson.

When you’re looking at valuing any investment in real estate – especially when there aren’t a lot of transactions to compare with – you need to take a view on what capital markets are doing, how they’re functioning and whether the money will either chase – for example (right now) 5% Treasury notes or chase the industrials.

That’s the basic asset allocation decision of most of the listed REITs, investment houses and sovereign wealth funds.

It’s a different market when you start talking about privates that are really chasing the yields down on sub-$25m assets. But at some point they’ve got to sit back and say, ‘I’ll throw my money into Treasury notes as well.’

So when valuing any investment, it’s prudent to have one eye on where yield markets and discount rate markets are going.

Trent on the importance of the interest-ratio cover  

It’s interesting you should say that Greg, I’ve had conversations with REIT clients that had to go down further and further in price point – just because there was so much appetite for the sector.

They were down buying things at sub-$20m and even around the $10m mark. They were able to outprice the private market because of the weight of capital that was coming into the sector.

But that is starting to change, and they’re now telling me… ‘If it’s under $20m we’re out, we can’t compete’ – and that’s again through the cost of the debt piece.

A good example I like to give is the interest-ratio cover which is a primary driver for being able to lend.

On a $20m shed at a 65% LVR – rewind the clock 18-months – and if you had peak debt sitting at roughly 4.25% – and the investment market was happy to buy that shed for 4.50% – that rent at that time back-solved to around $112/metre.

This was in line with the market – which is what prime sheds in Brisbane were renting for.

Now if you changed that peak debt from 4.25% up to say a 6.50% peak debt level now – that same shed – at the interest ratio cover of 1 and half times that debt – means the shed needs to rent for $158/metre.

This represents a 40% increase, just to be able to cover off that 1 and a half times ratio cover. So you can see where the motivation is for landlords to need to drive the rental growth story.

Trent on yield disparity

In truth, we’re most of the way through that rental growth to hit those hurdles, and right now they seem to be absorbing that cost.

But what it means is that we’ve now got a disparity in where the yield needs to be.

To maintain that $20m value on that higher rent it backwashes to around 6.3%. So no longer do we need to be buying things at 5% or anywhere near the 10-year bond yield in Australia at 4.75%.

But equally, we’re still seeing high-net-worth privates out of Sydney into the Brisbane market and a few other groups where it’s not necessarily about offsetting the debt piece. They’re petty lowly geared, they need to park their money somewhere and right now alternatives are still quite difficult to find with reasonable yielding returns.

So the mindset out there is an interesting one as to where rents can go, and alternative investment classes are a big driver as well.

TC: Are you seeing anything in other markets where there’s a specific investment driver, are they all value-add plays or is there a real attraction to cold storage logistics space or those types of subsectors?

VR: That’s a really interesting question, when we talk about sub-$20m piece, private investors are looking to park their cash somewhere.

The private investment play is super crucial and what they’re looking for is value-add, large land holdings (low WALE), where there’s the ability to get rental uplift going forward.

They don’t want to be stuck in a lease that’s 3% ongoing, they want to be able to re-rent that at a different price. Australia’s desire for fresh food/pharmaceuticals is high, and the need for purpose-built, specialised facilities (like cold storage) will continue to grow as well.

The greatest demand is still coming from the co-logistics/storage type users, all in various sizes and places around the market because that ‘last mile’ is really important.

Some of those inner crappier markets have all been able to take up space in secondary assets, which is why vacancies remain quite low.

TC: Greg, Sydney is a market unto itself, and out of all the investment yields around the country, Sydney got the lowest, and theoretically they’re the ones who need to backtrack the furthest, so how do you see things right now?

GP: Industrial land values in Sydney have been growing alarmingly, particularly around the new airport as it’s got closer to fruition in 2026.

The land values kicked off in the high $100 sqm and moved into $200 sqm with Mamre Road at $400 sqm, which is basically four un-serviced farm paddocks.

What’s driving the requirement for high rents are the infrastructure levies that are charged at the state level, which is $200,000/hectare developable. When you add the 6.5% local levy for roads to the inflated build costs, the delivery is huge.

TC: So why is there still appetite for land, surely at those numbers, it’s hard to make a development stack to get it out off the ground?

GP: The rent has to be pushed up to justify it, which means occupiers have got to justify it at their level too.

We’ve got service sales beginning to drop around the new airport that have kicked up from $550 sqm to $800 sqm and it’s seen as cheap by some users.

There are a couple of 24-hectare sites just sold where people have been quoted $1,100 -$1,300 for service sites closer in. All the instos are in there developing assets to dump into their funds.

When it comes to the redevelopment of industrial facilities, South Sydney is a frenzy of conversions. We’ve got four-level industrial properties being built, and there are a few bobbing up around Sydney, which is a new phenomenon.

There’s also a lot of rezoned land for residential, which makes it harder for the supply piece going forward for industrials.