Industrial property firing up

Economic conditions are increasing the attraction of industrial property.

Summary: In hunting for yield, more and more investors are turning towards the commercial property sector. And the industrial property sector is currently in a sweet spot for investors, with economic conditions pointing to a recovery.
Key take-out: One consequence of the massive underinvestment in non-mining assets is that quality stock in the industrial space is insufficient to meet demand.
Key beneficiaries: General investors. Category: Property.

Investors looking for yield are having a tough time at the moment. What with some brokers trying to put the fear of God into you about a banking bubble, everyone telling you the market otherwise is expensive, and that there is no value anymore. Oh, and China is having a hard landing and the mining boom has finished. Nowhere to run, nowhere to hide, if you believe all that.

The problem is, cash gives you little in return, which of course means the hunt for yield is still on. In that regard, one often overlooked area of the market is industrial property. It’s often said that you need a higher degree of expertise to invest successfully in this area, and that generally is true. But I don’t think investors should be scared off per se. The extra effort need not be burdensome and the returns are certainly worth it.

Yields averaging across the eastern seaboard make for a very attractive investment indeed, and according to property specialists at Knight Frank yields in the major eastern cities can range between 8-9%, and above (e.g. 13%) for some secondary properties (older industrial units). In any market that’s a very attractive yield. And don’t forget these are net yields; that is, net of your outgoings. In the industrial space, it’s common for tenants to pay 100% of outgoings – rates, insurance, land tax etc.

The question is, how as a retail investor do you get into the action and would now be the right time anyway?

There are a number of options or things to consider when looking at industrial property. Firstly, you need to consider in what way you want to invest. Typically there are three options open to retail investors.

  1. Act alone.
  2. Join a syndicate of private investors. There are companies, or syndicators even, like Sentinel Property Group, who can facilitate this. (But also read Ian Verrender’s recent article, Unlisted property realm carries a warning). This is quite a common method for retail investors to obtain exposure to higher value assets – anything from a block of residential apartments to horses. So, for industrial property it makes sense.
  3. Get your exposure through a fund or trusts like Charter Hall, Sentinel, or others.

There are obviously pros and cons to each of the above. If you act alone you’ve obviously got to commit a higher proportion of your capital, do all your own due diligence and carry all the risk. Nothing unusual in that though – it comes down to how much you want to invest and how much time you’ve got to do your own research.

Tim Armstrong, a director from Knight Frank, suggested that investors could start with as little as $500,000 for a small unit, or warehouse in say a complex of five or eight, or whatever. He noted, however, that this would typically be in in ‘secondary stock’, which is stock that is generally older – 10-20 years say – and not as well tenanted. Prime stock in contrast includes buildings and units that are generally newer and well tenanted. Now that’s not necessarily to say that investors should steer clear of secondary stock. Returns can be higher, but you’ll want to pay closer attention to what you buy. Run a closer eye over things – do your work and get to know the local economy where you buy. Talk to people.

If you have the time and are confident in your resources (doing your due diligence), and you are considering going it alone or as part of a small syndicate, there are some key things to remember or look out for.

  1. Secure, quality tenants.
  2. Make sure the guarantees are in place. It’s common practice for investors to receive guarantees for the performance of a lease. This can be either through a bank guarantee (for instance for a period of three to six months in the event a company folds) or from the directors. A bank guarantee is preferable.

Something else to consider if you are looking now though – especially for secondary stock – is that vacancy rates are generally going up in that space. Although, according to research produced by Frank Knight, this is largely due to increased stock in Brisbane as a result of tenancy upgrades to prime stock.

Joining a syndicate

The advantage of joining a syndicate or investing in trusts is that a lot of the above is taken care of or outsourced. Consequently, it can be a safer option for those who don’t have the time nor the inclination to conduct the full spread of research. You pay for it obviously and you could expect fees to be anywhere between 3-5%. Having said that it does open you to, or allow you greater access to, prime stock (generally higher value industrial property) and areas where, according to agents like Knight Frank, demand exceeds the availability of stock.

Typically demand for your ‘trophy assets’ – properties which are already tenanted with good covenants, and newer A-grade properties which carry less risk – is quite strong. But it comes at a premium and there seems to be some sharp competition in that space. Returns are also typically lower as a result – but again, it boils down to how much time you want to invest and your risk profile.

Timing an entry

So then, what about timing? Well, my read of the macro land suggests it is probably a great time to invest in this space, and the ease at which companies like Charter Hall are raising cash for their industrial funds probably backs that stance. I know sentiment isn’t great, but a lot of this reflects PR over the dollar. My read of the real economy, outside the rhetoric, is that the stars are aligning to make unlisted property very attractive – and that’s especially the case for industrial property.

Think of what we know. Consumer spending is robust, the mining boom doesn’t look like it will end for some years, the unemployment rate is low, and interest rates are at their lowest on record. Australia’s economy is accelerating, notwithstanding some softer quarters of growth, as is the global economy. Without any real headwinds to growth, it is only a matter of time, perhaps with a change of government here, before confidence again picks up.

Don’t forget, non-mining investment is about as bad as it’s been since the 1990s recession. For an economy with all the fundamental support Australia has got, that creates opportunities for investment. As mentioned above, one consequence of this massive underinvestment is that quality stock in the industrial space is insufficient to meet demand. Expect that trend to continue.