Rental growth: Why waiting for interest rates to fall might be a mug’s game.

The recent 25% slump in capital values has been driven by the increased cost of capital, but the big story of this downturn is that rental growth has continued – in contrast to the steep falls of previous slowdowns. 

Limited supply has helped: tighter post-GFC regulations, Brexit, Covid, the growth of online shopping and inflation/monetary tightening have all contributed.   

The fallout from ‘Trussonomics’ meanwhile worked to prevent over-supply in the booming logistics sector, supporting rental growth.  Likewise for residential, with the acute under-supply of space generating double-digit rental increases last year. 

Even the beleaguered office sector has seen rental uplift, albeit at the very top end.  The market is responding to the glut of secondary offices, with net office space continuing to fall and an ‘over correction’ possible at some point.  

A new development boom is not imminent.  Energising the planning system is difficult, while higher costs and exit yield assumptions continue to challenge development viability.  

Demographics will continue to drive residential demand, with the population expected to soon reach 70 million.  Despite remote working, demand for amenity rich and sustainable offices is rising, while rebased retail rents mean that good locations are well-positioned for growth.  

While affordability issues may dampen rental growth in some sectors (e.g. beds), there is scope for rents to accelerate, after decades of below trend growth and efficiency gains from technology and improved sustainability.  

While the risk-free rate was the standard benchmark for property yields, there were sustained periods when strong rental growth forecasts created a ‘reverse yield gap’.  So, history shows it is possible to make solid real estate returns without ‘free’ money.  

There is now a major opportunity to invest into a re-priced market with strong rental growth prospects. As active real estate managers, we have more control over asset level rental performance than exit yield and, if we get this right, we can deliver good returns for our investors. 

PBSA upgrades offer solid returns.

Recent research shows that while the student population has risen by 400,000 since 2019, the number of student houses has fallen by 19,000 in the same period, according to Sky News. For students going into their first year – and their parents – the problem is adding to an already stressful time.

The supply shortage has been compounded by a rapidly shifting demographic student mix. In the past few years, efforts to drive up the proportion of university students from lower socio-economic backgrounds have coincided with a high-inflation environment that has hit young people’s spending power more than most.

In the student housing market, the results have been predictable and well publicised, with providers struggling to deliver enough affordable beds for students whose only means to pay their rent is via maintenance loans. The market is struggling to solve this significant problem in a way that is sustainable for investors. Inflation is also responsible for the market’s inability to tackle the growing shortage of available beds for students.

In recent years, developing more purpose-built student accommodation (PBSA) has been seen as the solution. But higher land prices and building costs, and a congested planning system, make this an increasingly unattractive option for investors and developers.

In previous years, a steady stream of wealthy overseas students willing to pay a premium for newer, better-serviced schemes meant a focus on new build could be rationalised from an investment standpoint. But with uncertainty about Brexit’s long-term impact and changing rules for overseas students, investors will need to seek alternatives that cater to a wider segment of the market.

It’s not just the availability of beds but the quality that is causing a headache for university asset managers, with much stock failing to live up to student expectations – and to basic modern standards of safety and energy efficiency. Universities have an increasing number of assets no longer fit for purpose and in desperate need of investment in environmental, social and governance (ESG) upgrades and the resolution of cladding issues.

This is where a new opportunity for investors is emerging. Addressing issues with existing PBSA is crucial to improving student experiences and providing an inflation-hedged alternative to faltering new-build development. The shifts in students’ socio-economic demographics look to be with us for the long term, so focusing on improving existing affordable assets and investing in the needs of students from a wider range of backgrounds is a strong alternative to investing in new build for private capital.

This, and the mature nature of the sector, means refurbished PBSA stands to deliver robust occupancy rates, high yields and a strong return on investment.

As with any asset that has not been invested in for a long time, initial capex and proactive management are needed to ensure it is an attractive, Energy Performance Certificate-compliant and safe proposition for students. But even when improvements are costed in, financial outlays can come in at well under what new-build options would cost. In keeping costs down, rents can also be kept at a more affordable rate, which should promote a more enjoyable experience for what can be a daunting first move away from home.

PBSA is evidently in need of investment. Diminishing new-build PBSA returns must not put investors off deploying capital in the sector at a time when solutions are needed. It is the responsibility of developers and asset managers to put forward solutions that, primarily, deliver for investors, but also alleviate pressure on students and universities. These goals do not need to be mutually exclusive. The most pragmatic and cost-effective solution, and the means to achieve this, is to focus on improving existing stock.

Why ESG is everyone’s responsibility.

Yet, whilst the majority of real estate funds are firmly committed to making sure that their investments are delivering against ESG targets, many smaller firms, individual investors and family-led funds may not always be so keen, or able, to put environmental concerns and social value first.  

Away from the scrutiny of high-profile or institutional investors a clearly-defined ESG strategy might seem like an unnecessary luxury or difficult to achieve. From a regulatory perspective, there are several challenges associated with ESG best practice adoption, not least of which is simply the overwhelming number of guidelines, requirements, and their associated jargon to understand and adhere to.  Many are also put off by the way that some ESG data providers and reporting bodies assess progress, with some benchmarking smaller firms against some of the sector’s biggest players, who no doubt have significant sustainability teams and budget at their disposal.  

Evidently, there is a clear need for more education and more support. ESG can’t just be the preserve of those who are perceived to be able to afford it – we need everyone to be able to embrace it. For smaller funds and asset managers, that starts with work to embed clear ESG goals and guidance into their investment and asset management strategies, incentivising analysts and asset managers to consider investments’ environmental and social impacts, and not just occupancy rates or ROI.

It’s also vital to ensure that, in educating asset managers, you lean into the major upside benefits of adopting better ESG practices. Being overly focused on the punitive elements of relevant regulation and legislation can make ESG adoption seem like a chore. Chief amongst the benefits to champion are the green premiums associated with assets that have been developed or retrofitted to high sustainability standards. In the same way that underinvested assets can be marked down on price, struggle to attract tenants, or even become stranded, there is significant evidence to suggest that tenants and prospective buyers will pay higher rents and purchase prices, respectively, for future-proofed assets.

Developing a business culture which understands ESG as an essential bread and butter part of an asset manager’s job description, rather than a ‘nice to have’, is also imperative. The ESG agenda in property is being driven, at least in part, by the latest generation of property professionals entering the world of work. As a bottom-up priority, we need to both take advantage of their well-placed passion and help them to channel it into taking good ESG practices forward into future leadership roles. So as well as general training for colleagues, ESG-first practices should be drummed into new recruits from as early an opportunity as possible.  

With such training there can be a tendency to focus too heavily on the ‘E’ in ESG. Upskilling teams in ESG literacy must also take into consideration approaches to social responsibility and governance. At Clearbell, we take an occupier led approach, aiming to always punch above our weight when it comes to the amenities we offer relative to the size of the office. To achieve this in practical terms, what we’ve ensured is that our teams are implementing best practice processes around the measurement of tenant and local community satisfaction, as well as putting more emphasis on costs associated with placemaking when weighing up a prospective purchase. On the governance front, developing our proprietary Environmental Management System – a platform to provide all of our employees with the tools they need to embed ESG into their day-to-day – and delivery of our annual voluntary sustainability report has been strongly received by our investors and stakeholders.

For many of us, it’s clear that prioritising purpose in our investments needn’t come at the cost of profit and investor returns. However, not all investors, commentators and fund managers understand this. We need to do a better job of arguing the case for ESG and ensuring that detractors and those with knowledge blind spots understand that its purpose which increasingly drives profit and that failure to invest in ESG now will only yield more costs further down the line.

The future is retrofit.

Both approaches can result in the development of fantastic, design led and highly sustainable spaces, but I’ve always strongly believed that the greenest building is the one that already exists and that we’re often far too quick to go down the route of tear-down and rebuild. Upgrading older stock in most instances makes practical sense, makes business sense, and, most importantly, is the right thing to do to address the sector’s carbon footprint. However, it is important to acknowledge that there are also times when buildings are obsolete and should not be retained.  

Meeting targets depends on retrofit projects  

Retrofit is also an unavoidable necessity. Most stock that will stand in 2050 already exists today (UBS, Dec 2023), and concerningly, much of it is on track to fall well short of compliance with incoming MEES regulation changes in 2027. Indeed, over half on non-domestic real estate in London alone currently risks non-compliance (BNP Paribas, 2023). Tearing down all non-compliant stock and rebuilding is neither a practical, or cost effective option, which is why retrofit rates will have to quadruple in order to meet 2030 targets, according to Knight Frank analysis (Knight Frank, 2023 & UBS, Dec 2023). 

New buildings, evidently, cannot solve the sector’s carbon issues alone, and so failure to upgrade what we have will damage the overall sustainability performance of the commercial property space. 

We also mustn’t fail to acknowledge the reality of the current landscape. Planning authorities are increasingly coming down on the side of retrofit and are becoming more hesitant to approve the demolition of old commercial buildings. They understand that retrofit is inherently more sustainable and that repurposing the existing substructure, superstructure and façade of a building can be more cost effective.  

Though many fund managers will be put off by the high capital expenditures involved, what must be considered is the large discounts investors can demand on older, less energy efficient stock. Ultimately, we’re also seeing more and more evidence of the ‘green premium’ for assets that perform at the top end of the scale when it comes to sustainability. In London, that can be as much as a 19% boost to sale prices (UBS 2023). While capital expenditure on retrofitting projects can be significant, less efficient ‘brown’ stock trades at a discount. This can off-set much of the cost and make for an attractive yield play when compared to the outlays required for new builds. There are also other returns to be considered such as rental premiums, reduced voids, longer lease lengths and a higher chance of retaining tenants at future lease events.  

For prospective tenants, the levels of embodied carbon in a building is likely to become ever more relevant with future carbon taxation and disclosure models for businesses looking set to give more weight to embodied carbon levels. This will increase the appeal of retrofitted assets. With that, we’re expecting to see businesses being prepared to pay a rental premium for buildings that use less embodied carbon. 

Championing sustainable refurbishment 

The urge to champion exciting, statement new builds is understandable. New builds can be more marketable, and many prospective occupiers will be drawn to newness, as well as an opportunity to truly put their own stamp on a space that no one else has let before.  They also may benefit from reduced ongoing carbon consumption in operation due to optimal design efficiencies.  

In not challenging this – sometimes – blind preference for newness, however, we risk underplaying the potential of retrofitted assets. This is why it’s so important for us to upsell the, arguably, more worthy achievements of retrofitted buildings to those who may be less familiar with their benefits – including our clients, investors, planners and policymakers.  

I accept that this can be difficult when new build assets are just as likely to include all the latest sustainability features that a retrofitted asset would. Although, where retrofitted assets will always outperform new ones though is when it comes down to embodied carbon. When a building is constructed, carbon is embodied in its structure and façade. Retrofits work to keep as much of an existing structure as possible and so ensure that the developer can preserve significant levels of embodied carbon within the building. 

Take, for instance, what we have been able to achieve with the recent refurbishment of Grade II listed Kodak Building in Holborn. Once the historic European HQ of Kodak, the building now boasts 70,000 sq ft of contemporary office space with abundant tenant amenity. Knowing that many new tenants tend to alter or entirely rip out newly installed M&E, we only finished five of eight floors to shell & floor, without M&E installation. This approach also cuts down on wastage, cost, time and embodied carbon from use of unnecessary services.   

The upfront embodied carbon used in the Kodak retrofit was equivalent to the LETI 2030 Design Target which is relatively low even from a retrofit perspective. It also used considerably less embodied carbon compared to the Greater London Authority and RIBA benchmarks.  

Ensuring measurable progress 

In making a compelling case to both prospective occupiers and fellow industry stakeholders that retrofitted space can deliver the sustainability credentials that they’re looking for, we can’t rely solely on their favourable embodied carbon performance. We also have to demonstrate that such projects deliver what new buildings now deliver as standard.  

Assessing the environmental and social impacts of operations is a vital element of doing business in 2024. Alongside other factors like their employer brand or business need, a building’s green credentials are an important factor in a business’ decision to take on new office space. On this front, the adage that newer means better is often deep-rooted within prospective clients. But the fact remains that – from a sustainability monitoring perspective – there is very little that can be achieved with a new build that can’t be in a retrofitted space.  

It’s on asset managers to educate tenants about this, and to actively demonstrate how retrofitted buildings can be brought in-line with their expectations of newer buildings. This means asset managers should be working to develop spaces that come with smart technologies such as remote energy usage monitoring and power usage reduction as standard. These inclusions in a development can go a long way to helping prospective tenants to understand how their new office will support their own ESG goals. 

Ultimately the number of companies whose customers, shareholders and employees demand robust net-zero commitments of is increasing at a faster rate than the supply of green buildings (JLL). Building new is just one avenue that we can pursue, and it surely won’t fill the deficit on its own. So, it’s becoming more important than ever to first consider how existing stock can be upgraded before tearing down and starting afresh. Underutilising a retrofit-first approach, or not considering it as a vital part of a more holistic strategy to reach net zero, will result in a major failing on the part of the sector to deliver more sustainable options for clients and investors. 

Smaller industrial and logistics units are back in play.

Investors, in the rare instances where they are willing to deploy capital, are all looking for the same thing: value-add returns at core-plus risk.

With valuations continuing to fall across all sectors, it can be difficult to see where the best opportunities lie. Yields on good-quality London and regional city-centre offices may well be attractive, but there remains considerable downside risk. Rental growth is likely to remain strong across living sectors, but development or operational risk is required to deliver higher returns. So, what about logistics?

According to MSCI, logistics values fell by 27% between June 2022 and March 2023. There was a brief rebound of confidence in Q2, but that seems to have dissipated, and industrial yields are weakening once again. There are now pockets of new-build over-supply appearing in certain locations such as South Yorkshire.

So, while it doesn’t look as if logistics is going to get us out of a hole again as the sector did post Brexit and Covid, that doesn’t mean there aren’t opportunities for those prepared to look beyond the headlines and roll up their sleeves.

We have seen a real discount, confirmed by MSCI data, for single industrial assets in the £5m to £10m range consistently over the past decade. The recent price correction means that good-quality, smaller assets can now be purchased at strong initial yields given embedded rental growth. We haven’t seen this value for many years.

The pricing of these assets is well below replacement cost, which means it is impossible to increase supply at this price point, a key factor to drive future rental growth performance.

The other key driver, in the expected absence of another significant market-yield shift, is the ability to generate a portfolio premium at exit. When meaningful capital returns to the sector – and it inevitably will – it will pay for the ability to access scale, as we have seen in all previous market recoveries.

Of course, aggregation plays focusing on smaller units come with drawbacks, and they aren’t always economical assets for funds to manage. Acquisitions of multiple smaller assets can create significant transactional inefficiencies that threaten to negate any economies of scale achieved by holding many of these properties.

Conventional wisdom might suggest that the largest funds, with more resource and capital, can manage such inefficiencies well, but it’s often the case that significant bureaucratic pressures make aggregation plays difficult for them. This is why this strategy is often better executed by UK local specialist fund managers, who generally have fewer levels of bureaucracy and can be more flexible.

Significant opportunities

Similarly, some funds will be put off by poor energy performance certification on such assets – a common problem for smaller industrial units. The initial investment needed to ensure compliance can be a drag on yields. But for well-capitalised asset managers and those willing to remain focused on sale price further down the line, there are significant opportunities to drive outperformance.

With well-placed investment, revenue can be added through the provision of upgrades, such as EV chargers on site and the ability to provide occupants with power from solar panels.

Another concern for investors, given the current economic climate — and considering the typical target occupant for smaller units — will be the threat of SME failures. Insolvencies are at their highest rate since the financial crisis of 2008–09, and as it’s not clear whether failures have peaked, some hesitancy is understandable.

While not immune to their impact, the diversification present within aggregated small and mid-box portfolios offers a significant hedge against the impact of occupant churn and inflation. Ultimately, despite economic conditions, occupier demand for these units remains robust, and with inflation falling we may be through the worst.

Ultimately, discounted purchase prices, higher yields, great refit opportunities and premiums upon exit are making small and mid-box industrial and logistics units an asset class worth reassessing in these turbulent economic times.

When capital returns to real estate markets, aggregated portfolios of energy performance certificate-compliant units will come into their own. Naturally, such strategies won’t work for every fund, but for those willing to invest in upgrades and be flexible enough to manage multiple smaller assets, there are significant returns to be made, generated by the high running yield and steady asset management: value-add returns at core-plus risk.

Unlocking life science growth beyond the “Golden Triangle”.

There is some concern that the UK life science market may have peaked following significant recent activity. However, while it is true that research and development (R&D) investment slowed as the economic backdrop deteriorated in late 2022, the sector continues to offer significant growth opportunities – particularly outside the established ‘golden triangle’ locations.

The UK is home to some of the world’s leading scientists and research centres and continues to attract significant investment. Indeed, spending on R&D is expected to rise to 2.4% of GDP by 2027 from its current 1.7%.

The pandemic highlighted the importance of the sector and, following the UK’s leading role in the successful development of vaccines, the government pledged to become a ‘science superpower’ by 2030. Recent policy changes will support this ambition, including a newly formed Department for Science, Innovation & Technology and various measures in the March Budget (notably R&D tax credits).

Additionally, the UK is home to four of the world’s top 10 science and research medical universities: Cambridge, Oxford, Imperial College and University College London. Together, these three locations comprise the golden triangle, a rich community that has received 80% of all the UK’s venture capital funding in life sciences. However, the UK has world-class universities outside these locations, many of which have increasing access to funding and offer untapped investment opportunities.

As an industry, we are not engaging enough with the wider UK life sciences scene. Investors are failing to realise that there is an increasing number of locations outside the golden triangle receiving venture capital funding, bringing real estate development and investment opportunities that will support sector growth. These include Manchester with its world-leading innovation campus Alderley Park, Edinburgh with developments planned for the city’s BioQuarter and Birmingham’s Health Innovation Campus.

To unlock this potential, investors need to shift their focus – in much the same way that the US diversified beyond Boston, San Francisco Bay and San Diego.

First, there is less competition. Demand for suitable space greatly outweighs supply and it is becoming increasingly difficult for investors to find value and suitable buildings. Moving beyond the golden triangle means less competition and the potential to deliver strong risk-adjusted returns.

Second, there is a less mature market. More affordable rents for occupiers and cheaper living costs for employees may indicate potential for stronger rental growth, compared with more established locations. Some occupiers are pursuing significant expansion plans, with Labcorp expanding in Leeds and increasing its capacity by 30%.

Finally, strong demographics. City centre living is growing in Manchester, Birmingham and Leeds – with all three locations seeing population growth and good career opportunities supporting high graduate retention rates. According to the Department for International Trade, 50% of life sciences jobs are located outside London, the east of England and the South East, and these figures are set to grow significantly over the next five to 10 years.

Growth in the sector is set to accelerate – and the commercial real estate industry should focus more on the UK’s emerging life science markets, to help realise its aim of becoming a truly global science superpower.

Sustainability is the starting point for decisions, not the afterthought.

The same goes for the real estate and private equity sectors through the neatly coined term “responsible investment”. With the built environment responsible for nearly 40% of global carbon emissions, reducing the environmental impact of real estate is a key priority for investors and corporate occupiers.

Most notably, property valuations are factoring in sustainability metrics, or lack thereof, of a building far more than they were even last year – and in some cases, for the very first time. This naturally filters down to PE firms and their decision-making process. The mid-market, in particular, needs to be aware that their lenders are increasingly focused on sustainability issues, including access to capital. This means looking at their strategies from acquisition through to disposals to ensure that capex is factored in from the beginning and embedded in the business plans from the get-go. EPC assessments are just one of example of how to develop cost and action plans to improve building performance. Though, it has of course been interesting to see wider discussions within the industry about whether EPC ratings are indeed the best way to drive the decarbonisation of commercial property.

This brings us on to the second most notable direction of travel – embodied carbon. It has risen up occupier and investors’ agendas, as we focus more on life cycle consumption than operational consumption. There has been a tremendous a shift, wherever possible, towards retrofitting assets rather than rebuilding them altogether. In many ways, a more sustainable building is one that already exists, and PE companies must start conducting life cycle analyses on buildings to understand how they will perform from acquisitions to disposal, how much carbon you are saving and how you can bring down your overall carbon footprint. This is something that every medium-sized PE firm should – and in many cases will already – be looking at. Repositioning and refurbishing existing buildings to meet the evolving needs of society and the economy allows us to reuse building materials and historic sitework, which can reduce emissions significantly when compared with a new build.

Thirdly, there has been a shift in the importance of working with your community and the social benefits that this can bring. Indeed, we are now in a time where businesses must be proactive – not just by putting the environment first, but also by being considerate about the local community. By creating a strong social strategy that puts the people first, businesses can enhance the value of their assets whilst ensuring it serves the local community. Development used to be something you did to a community; now it is something you do with a community. Our work at the new mixed-use business park in Maidstone, Kent is testament to this. With Phase 1 substantially completed at the end of 2022, the development will also include nearly 12,000 new trees and four wildlife ponds. The buildings themselves include solar panels and electric vehicle charging points aimed at reducing carbon emissions. Finally, a new electric bus service and cycle lane to Maidstone town centre are being created to reduce car use. This was all developed in partnership with the local community and will therefore serve them in the best way possible.

We need to embrace sustainability initiatives in the same way that we encourage profits and dealmaking, rather than looking at it as a tick-box exercise that we implement for the sake of it. For the mid-market, it needs to be embedded in all our thinking and in everyone’s roles across their teams. Sustainability is the starting point for decisions, not the afterthought.

Adaptable investors will succeed.

Across the private equity real estate fundraising market, and indeed financial markets more broadly, investors are either pausing for thought or actively shying away from Europe, as this new dynamic plays out. Realistically, it is also likely that a number of large institutional players will sell down their assets as a direct consequence of the liability-driven investment debacle or due to redemption calls.

However, it’s important to recognise that the very nature of the market is cyclical. The commercial real estate sector has long had a turbulent history, at least over the most recent past. Periods of sharp and dramatic appreciation in capital values have often been followed by periods of considerable decline in the short term. But by looking back at past cycles, history tells us that the industry always recovers – or, better still, remodels itself – in the long term and largely for the better.

Looking back at the 1980s, this was a time when commercial construction soared but inevitably led to an enormous oversupply of commercial space and created serious financial problems for many investors. Following the early 1990s recession, property values only recovered to within 15% of pre-crash levels after five years – again causing a long, painful period for investors.

Equally, the commercial real estate market was heavily affected by the global financial crisis, with the overall value of assets falling almost 27% in 2008. These were indeed scary times. In each case, the winners reacted by diversifying, taking a strategic approach and holding their nerve until the economy fell back into shape.

We are experiencing several headwinds right now. There’s no question about it. Inflation has proved stubborn, leaving the Bank of England little choice but to hike interest rates for the eighth time since last December, in the biggest rise since 1989. The energy crisis is curtailing the ability of consumers and corporates to spend. Economic growth is weakening.

Yet despite the current economic downturn, there are still many opportunities – just look at the remarkable strides in the life sciences and logistics sectors, the increasing diversified portfolios in regional spaces and the return to the office.

Commercial real estate isn’t a one-size-fits-all investment and many investors have managed to weather several economic downturns by focusing on the right assets during difficult times. Some of the best investments made during my career have been at the bottom of the cycle.

We can’t predict exactly when today’s headwinds will eventually subside as they have in the past. But history shows that investors who adapt and hold their nerve are likely to end up with a better long-run outcome. So, instead of focusing on the negatives, use your time where necessary in pivoting the business or identifying the opportunities that the downturn, and eventual recovery, will create.

Logistics — the party isn’t over, the music has just been turned down.

The answer is nuanced. The party is certainly not over, but the music has been turned down a couple of notches and you need to be savvier in how you go about unlocking value.

Whilst the general market has to some extent cooled, the logistics sector continues to be the main beneficiary of the strong growth in online shopping and the structural shift in how we commission and distribute goods and services. Wider than this, the sector plays a huge role in job creation regionally and supports the government’s levelling up strategy. According to Knight Frank’s 2022 UK Logistics Market Outlook, industrial rents are expected to rise by an average of 4.2% per annum over the next five years, compared with 1.7% per annum for offices and 0.6% per annum for retail.

Looking at the current climate, two factors remain at the top of the agenda: high inflation and rising interest rates. These factors are dominating and weighing on business and consumer sentiment. In the short term, it means weaker growth and potentially, a technical recession.

We can already see the effects of this on the logistics sector – which has reported weaker investment pricing and a softening of yields over the summer.  However, the occupier market is going into this period in a position of strength.

Data from Colliers shows that supply has not matched the surge in demand. According to CBRE, take-up of UK logistics space totalled 10.43m sq ft in Q1 2022, representing an increase of 100% compared to Q1 2021 which saw take-up of 5.21m sq ft.

In terms of Clearbell’s strategy, we continue to see the logistics sector as the ‘star performer’ of commercial property, with its underlying supply-demand dynamics still representing a compelling reason to invest. We have developed two key strategies to drive our plans forward, namely Project Tudor and Project Carter.

For Project Tudor, we have aggregated a portfolio of smaller development sites where there was less competition and have redeveloped these spaces into logistics sites to meet growing demand in urban spaces. The experience we have gained from developing similar portfolios – such as the Cara portfolio of 22 logistics assets which we sold to Blackstone a couple of years ago – has helped enormously on this project.

For Project Carter, we have acquired warehouses below replacement costs and refurbished them to maximise their ESG credentials and deliver space more quickly to under-supplied local markets. This is a more defensive strategy in a part of the market which has more limited competing supply and offers more affordable rents for occupiers. We have also targeted locations in the Midlands and North West where there is a strong labour pool – which is becoming increasingly key for tenants who want to commit to long-term leases. 

These projects show that you can address low supply in a cost effective and ESG friendly ways, without always resorting to new build or build-to-suit options. As the industry is aware, getting planning permission can be difficult, so refurbishing existing spaces to a Grade A standard can be a lot easier to achieve in practice.

In conclusion, while the volume has been turned down a bit, the logistics ‘party’ looks set to continue a while longer, as the structural shift to online continues. However, going forward, investors will need to learn from their previous experiences and modify their strategies in order to be successful at unlocking value.

Breaking the vicious circle of logistics supply

This sector is trapped in a vicious circle. We’ve been seeing for years that logistics supply is not keeping pace with demand. 

The pandemic has accelerated trends such as online shopping, further driving up demand. And development has become more difficult amid supply chain disruption and a shortage of labour and building materials.

We’re therefore likely to see a continuation of a lack of vacant space for many years to come, which will ultimately drive up rents in two key ways: first, higher costs will deter development, meaning available space will continue to be squeezed and rents will inflate; second, those developers that do decide to build will need to hike rents to pay for construction. This is due to play out over the next couple of years – and it may mean that rents become unmanageable for some tenants.

This may result in tenants being displaced to cheaper locations. We are also seeing an increasing amount of regional businesses that would have traditionally split their operational activities from their office functions now combining them into new warehouses, given the improved quality of these assets. This ‘co-location’ thereby significantly reduces their office rents, which helps to balance the increasing cost of renting their industrial space.

Nick Berry, Partner at Clearbell Capital