Industrial property waits for the bounce

The industrial property market has stabilised and returned to a modest growth pattern in 2011-12, in line with improvements to the domestic economy and financial conditions.

The growth in inventory levels, imports and manufacturing activity, though subdued, led to increased demand for industrial property space. This has strengthened the key property fundamentals such as rental rates, property values and yields (rents divided by property values) during the year.

IBISWorld estimates that revenue for the Industrial and Other Property Operators and Developers industry in Australia will increase by about 4.4% to $21 billion in 2011-12. Over the past five years, revenue is estimated to have declined at an average rate of 0.1% per annum.

The industry performed poorly in 2008-09 and recorded flat growth during 2009-10. The global financial crisis had a resounding influence on the industrial market and substantially reduced the demand for industrial products. As a result, the demand for property space was negatively affected, leading to revenue decreasing by 11.6% in 2008-09. In October 2010, the International Monetary Fund reported that it expected 3.5% growth in Australian industrial property in 2011.

The future of the industry looks promising. Steadier demand for industrial products is expected to return to the market from 2011-12. This demand should come from improving economic conditions, such as gross domestic product (GDP), employment, wage levels and business confidence.

These improvements to the domestic economy, combined with increased access to finance, are expected to drive business spending volumes and, consequently, demand for industrial products.

This is anticipated to increase the demand for industrial space through strengthening manufacturing production, import volumes and inventory levels. Incorporating possible volatility, over the next five years through 2016-17 industry revenue is forecast to grow by an average annualised rate of about 0.1% to reach $21.1 billion.

Industry Outlook

IBISWorld forecasts that industry revenue will increase at an average annualised rate of 0.1% over the five years through 2016-17 to reach $21.1 billion.

Revenue growth in 2011-12 is expected to surpass 4.0% for the first time since 2006-07, as steadier demand for industrial products returns to the market.

The growth in demand for industrial products is expected to be driven by improvements in the economy and financial conditions.

The China-fuelled commodity boom, which is expected to feed through to business profits, will aid growth in Australia’s gross domestic product. Improving domestic employment, wage conditions and a rising exchange rate and business sentiment are also likely to drive GDP growth.

These improvements to the economy, combined with the increased access to finance, will encourage business and retail spending and will consequently raise demand for industrial products in the short term. However, international uncertainty and rising consumer caution are likely to reduce demand as quickly as it has recovered from the global financial crisis.

The impact of trade

Improvements to the national economy over the next five years are expected to boost inventory volumes.

Inventory volumes are the major determinant affecting demand for industrial property space, and thus affect property fundamentals and industry-wide revenue.

The growth in inventory volumes over the next five years is expected to stem from increased imports and manufacturing activity.

IBISWorld forecasts Australia’s import volumes will increase by about 7.0% per year over the five years through 2015-16.

The relatively strong Australian dollar and solid domestic demand for goods and services over that time are expected to aid growth in import volumes.

Manufacturing activity is also anticipated to grow steadily, as both domestic and international demand for industrial products increase. The expansion of inventory levels, as a result of improved manufacturing activity and import volumes, is anticipated to increase the demand for industrial property.

The rise of online retail will promote greater demand for logistic channels and warehousing activities, which will subsequently require a greater amount of industrial property to deal with. This is also likely to lead to the development of “dark stores”, or superstores that cater specifically to online orders.

Demand factors

While prime property currently remains the most sought after, expected growth in secondary-grade properties is expected to increase until the supply of prime property increases.

Property fundamentals, such as rental rates, property values and yield rates, are expected to be influenced by the increase in demand for property space.

Rental rates are anticipated to increase as investor and occupier confidence returns to the market, while supply slowly increases in response to greater demand.

From 2011, asset values across the market are forecast to rise as economic conditions improve, industrial demand increases and access to capital becomes easier.

Due to the stable growth in rental and asset values, retail yields will likely remain steady through to 2015-16.

Growing demand for industrial property space is expected to aid industrial construction and improve the key property fundamentals.

Construction was constrained in 2010-11 and this is expected to continue into 2011-12.

However, the increased demand for industrial space through 2016-17, combined with improving access to finance, economic conditions and company profit margins, is expected to increase industry construction activity.

The positive position of the industry is expected to bring greater foreign investment, like Singapore’s GIC acquisition of Salta Properties in late 2010, along with two other properties in June 2011.

Until the end of 2011-12 the industry is expected to be dominated by owner-occupiers rather than investors.

This is due to the market’s slow re-emergence from its financial crisis slump creating lower speculative demand.

Greater global demand for Australian industrial property, despite its high volatility, will create a stronger market of both buyers and sellers who are looking to reduce their risk exposure by dismantling their industrial market investment operations gradually. Thus, significant investment fund portfolios are expected to change hands over the next five years.

As with most types of property and investment, industrial property tends to exhibit cyclical trends.

In 2011, the construction market for industrial and other property operators had swung past the lowest point in its cycle, with construction activity expected to pick up in the medium term.

Melbourne had some speculative development during 2010-11, but leading into 2011-12 the activity has largely been determined by pre-commitments from tenants.

As confidence builds in the Australian and international economies during the next five years, more speculative construction activity in the industry is expected in Sydney, Perth and Brisbane, following the resumption of normal economic conditions after the January 2011 floods.

Key Success Factors

IBISWorld identifies 250 Key Success Factors for a business. The most important for this industry are:

• Financial structure of the company: A strong balance sheet and access to funds allows companies to respond to changing economic conditions.
• Management of a high quality assets portfolio: The effective management of assets and tenants enables landlords to maintain high occupancy rates.
• Ability to acquire quality assets: In the industry, it is necessary to acquire quality assets that will grow in terms of their rental rate and capital value, as it aids in revenue growth.
• Market research and understanding: Thorough analysis of economic, demographic and property market conditions provides companies with an overview of the industry. This allows the effective targeting of opportunities and management of slowing economic conditions.

Barriers to Entry

Barriers to entry in this industry are medium and are steady.

The Industrial and Other Property Operators and Developers industry has several barriers that can prevent new companies from establishing. The largest barrier to new property operators is entry costs. This includes the costs associated with financing and acquiring property assets, and the initial marketing, development, advertising and research expenses.

Direct investment in prime property assets requires significant financial resources and often prevents new entrants establishing themselves.

Zoning regulations can also be a barrier to entry. Typically controlled by the local governing body, zoning regulations are relatively universal, although each local council usually has different rules and regulations. Zoning regulations control the physical development of land determining which uses may be allocated to each property site.

Besides restricting land and building uses, zoning laws also regulate the dimensional requirements and the density of a development, and therefore can act in limiting the availability of suitable land for development.

Karen Dobie is the general manager of IBISWorld, Australia’s richest source of business information.