Demand for T3 sheds fuelling huge growth

COMMENT: It is no secret the UK industrial warehouse sector offers some of the most sustainable rental growth in the UK real estate market. We recently IPOd Warehouse REIT, where average rents in the seed portfolio we acquired were just £4.77 per sq ft, writes Andrew Bird, managing director of Tilstone Partners. It is unsurprising then that investors who are seeking sustainable income with a propensity for growth, from sovereign wealth funds to large institutions to wealth managers to retail, are looking to the sector more than ever. Warehouse REIT’s investment proposition is based on offering exposure to Tier 3 UK warehouse assets – last-mile, multi-purpose, sub 100,000 sq ft – held within an income-paying listed structure. Having leveraged a combined 90 years’ of sector experience and assembled a 27-asset portfolio, our preferred option of a listed REIT, instead of a propco or private capital route, provided a number of advantages: improved economies of scale; long-term capital structure; enhanced debt structures, all within a tax-efficient wrapper. It also allowed management to continue to co-invest in the sector, demonstrating our long-term commitment. It is worth reiterating some of the statistics. While low rents have been a feature of the sector for some time, the shrinking vacancy level – now less than 5% – is a newer phenomenon, having reduced from double digits over the past five years. There is no more than 18 months’ supply currently available, on an average take-up of 80m sq ft. Over the next five years, UK internet sales are forecast to almost double from last year’s 14% of market share, and with every delivery being handled by at least one warehouse, continued demand for space is inevitable. In any other sector, this scarcity of stock would have triggered a development boom, but this is simply not happening. Why? Our seed portfolio was valued on admission at £63 per sq ft., against a building insurance value of £84 per sq ft; an example that it simply isn’t viable to build multilet industrial/warehouse estates. This economic moat around supply is unique to Tier 3 warehouses, in stark contrast to big box, where build costs are below £40 per sq ft. While underlying fundamentals are strong, the sector is already facing headwinds, notably the keenness around pricing. News of another joint venture or recapitalisation in the sector involving an overseas investor has been an almost weekly occurrence. Yields are compressing and alternative uses, especially residential, are competing for the same assets. More than ever, the focus on individual stock selection and portfolio management will be the key to outperformance. With as much as 30% rental growth required before any new development arises, the income appeal of the sector is easily understood, with consensus predicting 3% rental growth per annum for at least the next five years. For the new and enlarged shareholder base, the REIT has provided access to a specific subsector of the UK warehouse market. The variety of investor and appetite for the stock surprised even us. Competition is increasing as the sector’s popularity grows, but with occupier demand expected to drive rental growth, and with the UK industrial market having on averaged witnessed £8bn of stock traded each year, it is an exciting time to be launching a listed vehicle.