A combination of macro issues sparked by September’s mini budget including a new prime minister, further interest rate rises, increased inflation, energy price hikes and industrial action meant a tumultuous end to 2022.
The extraordinary capital growth that the UK industrial property sector experienced from 2020 until the end of the first quarter of 2022 has seen an abrupt change as the market has declined quickly and significantly.
So, against this less than auspicious end to last year, what does 2023 hold for the UK urban logistics sector and for Chancerygate?
Consensus opinion appears to be that the Bank of England (BoE) base rate will peak at a lower level than first thought, but still above four per cent, with Deutsche Bank saying it will reach 4.5% by May next year and ratings agency Fitch as high as 4.75%. It is unlikely that the BoE will begin to reduce base rates until the second half of 2024.
We are therefore going to have to get used to a higher rate environment and the implications on our sector.
The other punitive macroeconomic force, which the interest rate rises are trying to curtail, is inflation. It is impacting occupiers and developers alike in terms of increased variable and fixed costs.
This is particularly pertinent to our business when we consider build cost and affordability of occupational costs for our tenants.
That said, the year has started with more positive sentiment than expected as the UK avoided recession in 2022.
Supply Demand dynamic
Occupiers are facing a triumvirate of challenges this year:
Higher interest rates and significant price inflation is likely to temper occupational demand, reducing companies’ plans to expand and upgrade accommodation. An increased rate of insolvency may ensue and will negatively affect vacancy levels.
However, this can be balanced against the very low levels of availability for, and a shortage of supply of, Grade A urban logistics accommodation.
Although supply will inevitably increase over time, it is currently at record low levels, so it is unlikely that the balance will swing too far in the other direction, particularly for Grade A stock.
ESG, the EPC timebomb and the effect on rents
Despite the current macroeconomic environment, there is still strong demand from investors, and increasingly occupiers, who want better quality accommodation with excellent ESG credentials.
Recent legislation – the Minimum Energy Efficiency Standards (MEES) – requires all non-domestic properties to have an EPC B by 2030.
According to research on the UK multi-let industrial property market by Gerald Eve, this has brought EPCs to the forefront of landlords’ attention, not least because 88% of non-domestic properties will need to be improved over the next 10 years if they are to remain compliant with MEES.
The EPC timebomb is ticking for secondary stock and, unless it is addressed, it will not be possible for non-compliant buildings to be let, further driving demand for primary stock.
This presents Chancerygate with a significant opportunity due to the Grade A sustainable accommodation that we develop. We are more committed than ever to ensure that our developments allow occupiers to operate within our units in the most sustainable manner.
We anticipate sustained, but lower, rates of rental growth and prime yields stabilising, with the price gap between primary and secondary stock becoming wider. This does not necessarily mean primary stock will be more expensive, but instead that demand – both occupational and investment – for secondary stock may diminish.
A central pillar of the fund’s strategy is to acquire assets where we can add value by improving EPC and ESG credentials of existing stock.
We are focusing on finding assets that might not have the right EPC ratings now, but we can see a defined path in our business plan to significantly improve them through our hold period.
The continued success of our partnership with JRC is evidence that there is ongoing demand from a myriad of entities and jurisdictions for UK logistics property of all types.
Investors can see past the short-term challenges outlined earlier rather believing in the longer-term prospects with an asset class they regard as particularly resilient.
We are going to accelerate our expansion into Europe this year which will be driven forward by our new European director, Jason Sharman.
This follows on from last year’s announcement that Chancerygate entered the European market for the first time with the €4.5m acquisition of a five-acre site near Dublin airport which we purchased in partnership with Bridges Fund Management.
Market fundamentals in Europe are very similar to the UK, but ecommerce penetration is much lower. There is no reason that ecommerce in Europe won’t be at the level it is in the UK within the medium term.
There is a paucity of high-quality, sustainable stock in Europe. There is plenty of big box development, but relatively little focus on urban logistics accommodation, and that is where we see the opportunity and will be focusing our time.
Always look on the bright side
Whilst the UK economy and urban logistics property sector is facing several challenges, at Chancerygate we are cautiously optimistic about the year ahead.
We know there is significant demand for our product from investors and occupiers, and we have a £150m fund that will acquire and enhance assets to ensure they are MEES compliant.
We currently have more than 3.2m sq ft of urban logistics space under construction or ready for development across 24 sites ranging from Bournemouth to Edinburgh. In addition, we manage in excess of £385m of assets across more than five million sq ft of commercial space in over 480 units.
When this is combined with our ambitious European expansion plans, we have a busy year ahead and, despite the current outlook, we are focused on continuing to expand Chancerygate’s horizons.
Chancerygate offers urban logistics units freehold or leasehold in strategic locations across the UK. To view our latest developments, click here.