Time For Rental Growth

Yield compression has been dramatic over the last 24 months within the Polish industrial market whilst the added attraction of ‘rental growth’ has often been overlooked.

Dry income producing investments of significant volume with long-15 year plus leases to popular name tenants are compressing to ca. 5 pct. More asset management angled investments, such as multi-tenant parks, are hotly pursued by funds with a view that yields will come in to something like 6.25 pct from 6.75 pct.

However focus now turns to the question of rental growth. In the current landlord market developers are selective in undertaking new projects unless it makes business sense at a required return and to do this rents have to match their costs plus a profit margin. Developers cannot build at replacement costs. The factors that are causing an upward push in rents include:

1. The dramatic increase in material construction costs, labour and associated soft costs over the last two years.

Price tracking shows an increase of over 20 pct during this time period. Also tenants with specific building requirements have become more common and it is costly to meet both their corporate regulations as well as the need for efficient and competitive buildings with high specifications. According to Eurostat data labour costs in the construction sector recorded y-o-y growth of 10.0 pct. According to Sekocenbud construction costs increased by 4 pct and installation materials by 3.5 pct over this time.

2.The Availability of contractors.

Finding an available contactor is difficult and this can lead to time delays coupled with the contractor often trying to work over winter periods to meet time frames, which all add to costs.

3. A surprisingly limited number of developers building new space in Poland.

Many warehouse owners are just asset managing and not building substantial new space despite demand being strong.

4. Increases in land prices and lack of suitable sites.

Regulations restricting zoning changes for industrial purposes are having a knock-on effect in increasing land prices. Regulations from 2016 now prevent the free trade in agricultural lands with areas exceeding 3,000 sqm and zoning changes have become ever so much more complicated. Also adequate infrastructure such as electricity and storm water drainage is a must and often lacking.

5. Vacancy rates are reaching all time lows and the choice of suitable space of the correct size for an occupier is limited.

This inhibits rental negotiations and is starting to kick through into more stabilised rents. Vacancy across Poland stands at just over 5 pct and in some regions it is much less. Banks are still unwilling to fund speculative developments and new build generally has to be led by pre leases so oversupply in the short-term caused by speculative development is unlikely.

Although headline rents are yet to see much growth, the gap between effective rents (rent after incentives such as: rent frees, fit-out contribution, cash contribution) and headline rents is narrowing substantially. It could soon be the time for solid rental growth in the industrial market as has been witnessed in Germany and much of Western Europe over the last five years. An increase that is perceived as small in monthly warehousing rent from say EUR 3.00 per sqm to 3.30 per sqm is actually a 10 pct increase in terms of net operating income for the investment owner that would produce very exciting returns over the hold period or on exit sale.