Summary and outlook
In the face of a major COVID-driven recession, the logistics sector performed with remarkable strength in 2020. It more than weathered the storm, as the pandemic stimulated new demand and accelerated structural changes, pushing the occupier and investment markets to new highs.
SCALING NEW HEIGHTS
UK industrial and logistics take-up hit a record 59.7m sq ft in 2020. While the pandemic suppressed demand in other parts of the property market, it actually stimulated logistics sector activity. The pandemic had both a direct impact on demand, as significant volumes of additional warehouse space were required by PPE supply chains; and indirect impacts, with increased online retail activity encouraging major ecommerce businesses to push ahead with expansion plans.
Amazon grabbed the headlines, accounting for an extraordinary 20% of national take-up in 2020, including three 2m sq ft-plus deals. Nonetheless, 2020 would have been a record year even without Amazon’s mega-deals. Demand stemmed from a variety of sources, with parcel delivery companies, supermarket chains and emerging ecommerce firms all firmly in growth mode. The larger end of the logistics market was the main beneficiary of increased demand, with take-up in the XL segment (250,000 sq ft-plus) surging to a record 28.0m sq ft, up 33% up the previous high.
ECONOMIC RECOVERY AHEAD
The strength of the logistics market’s performance in 2020 is all the more impressive when set against the backdrop of a severe, lockdown-induced recession. GDP contracted by 9.9% in 2020, the worst year for the UK economy in more than three centuries. Positively, the planned phased reopening of the economy over the spring should set the foundation for a strong rebound starting in Q2. The economic recovery is expected to be consumer-driven, and supported by the record levels of household saving seen over the last year.
ONLINE GROWTH FUELS DEMAND
The economy has been reshaped by the pandemic, and there will be lasting impacts on consumer and business behaviour. Of most relevance to logistics is the step change in online retail activity triggered by COVID lockdowns. The online share of total retail sales rose from 19.2% in 2019 to 27.9% in 2020, and it hit a new high of 36.3% in January 2021.
While online retail’s market share will scale back when restrictions are eased, a permanent boost to online activity will remain, elevating demand for logistics space over the long term. Capital Economics forecasts that the accelerated transition to online retailing will boost demand by an additional 15% over the next decade, taking the total volume of extra industrial space required in the UK during 2020-2030 to 110m sq ft.
Brexit was pushed down the headlines by COVID-19 during 2020, but the ending of the transition period at the turn of the year has brought it back into focus. A hard Brexit has been avoided, and fears of huge traffic jams into UK ports have proved unfounded, but the extra red tape and costs caused by new trading arrangements have undoubtedly caused disruption for exporters and importers.
While companies are still getting to grips with the new trade environment, some are already making efforts to restructure operations and supply chains to minimise potential tariffs and delays. The restructuring of supply chains could generate increased demand for UK logistics space, especially if companies decide to keep increased volumes of stock at UK warehouses, close to domestic customers. A trend towards reshoring, which has also been encouraged by supply chain disruption caused by the pandemic, could see companies opt to manufacture more goods in the UK or to source more parts from local suppliers.
RENTS STILL RISING
In spite of a sustained period of development, strong demand has kept supply levels in check and fuelled ongoing rental growth. In contrast with other property sectors, logistics rents continued to rise strongly in 2020, with prime rental growth for 50,000 sq ft units averaging 4.2%. Growth was strongest in Greater London, the North West and the East Midlands in 2020, each of which recorded average increases in excess of 7%. Secondary rents also rose, albeit by a more modest average of 3.7% nationally.
However, the pace of rental increases is likely to ease somewhat in 2021, as new stock coming to the market reduces supply pressures in certain parts of the UK, particularly in the larger size bands. Nonetheless, set against expectations of falling rents in other sectors, a mere moderation in growth is impressive in a relative context.
INVESTORS DRAWN TO LOGISTICS
Mirroring occupier market trends, investment activity also surged to new heights in 2020. £6.9bn of industrial assets changed hands in 2020, including a record £5.5bn of distribution warehouses. A wave of pent-up demand was released in Q4, with the investment volume hitting £3.4bn, comfortably a record for an individual quarter. Overseas investors drove the market, particularly at the larger end, accounting for close to half of the annual investment volume.
Logistics property was already in the sweet spot for many investors prior to the pandemic. Its appeal as a safe haven from the heightened uncertainty in other property sectors has only grown over the last year. Strong investor demand pushed prime logistics yields to new record lows in 2020, with long-leased distribution warehouses in the South East hardening to 3.75%. Prime yields are expected to go even lower in the next twelve months.
DEVELOPMENT POWERS AHEAD
The pandemic had a much smaller impact on speculative development than had been initially feared, with disruption to construction activity largely confined to the first lockdown period in H1. For units over 50,000 sq ft, a record 11.5m sq ft of speculative space was under development at the end of the year. Developers have increasingly gravitated towards the 100,000-250,000 sq ft size band, where the volume of speculative space under construction increased by nearly a third over the course of 2020.
Speculative development activity will continue to have strong momentum in 2021, with 13.7m sq ft of new starts expected to commence. Development will remain skewed towards larger units, as 11.6m sq ft of this total is in projects over 100,000 sq ft. The mid box market appears less well served, with a more modest 2.1m sq ft of speculative development starts anticipated in 2021.
Evidence of yield compression and ongoing rental growth has fuelled large increases in land values, with prime values in locations monitored by LSH increasing by an average of 14% last year. The East Midlands and Greater London saw the largest increases, with both seeing values rise by 19%. Further significant increases in land values are expected in 2021.
While logistics property demand has been boosted in the short term by trends arising from the pandemic, the sector is also set to see long term gains as a result of accelerated structural changes. Logistics property has a secure role to play in supporting postpandemic economic activity, which puts it in stark contrast with other property sectors where the longer term impacts on demand remain clouded with uncertainty.
After a strong end to 2020, occupier and investment market activity slowed briefly at the start of 2021, due partly to the impact of renewed lockdown restrictions. However, backed by a healthy pipeline of occupier requirements, there has already been a reacceleration of leasing activity during Q1. The prospective economic recovery, continued expansion of online retailers, and healthy levels of speculative development all point to another busy, if perhaps less spectacular year ahead for the logistics market.
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