As confidence returns, so will the tenants

Highbrook Business Park in Manukau which recorded the highest increase in occupied floor space over the year. Photo / Supplied

Development activity in the Auckland industrial market is at its lowest level for years, but some increase in tenant demand is expected as the economy works its way out of recession, says Bayleys Research in its latest overview of the market.

Bayleys' senior analyst Ian Little says greatly reduced development activity has slowed land absorption significantly while vacancy rates, which have been at historically low levels for most of this decade, have come under pressure in some precincts.

The impact of the cooling economy on the Auckland region's industrial property sector is well illustrated by the result of recent land uptake and vacancy surveys in the Manukau City and North Shore industrial precincts.

The slowdown in development activity is particularly evident in Manukau City, the region's largest industrial precinct.

Land absorption over the 2008-09 survey period was recorded at just below 17ha. With the exception of 2002, this is the lowest level of uptake recorded since the mid-1990s. The absorption figure peaked in 2003 at 76.1ha, with the average annual uptake between 2003 and 2008 sitting at 63ha.

"The slowdown is, of course, unsurprising given the economic background which has made development funding extremely difficult to source, while a majority of businesses have been focused on consolidation as opposed to expansion," says Little. "Funding is generally only available for projects that can demonstrate significant tenant pre-commitment and this has curbed speculative development."

The North Shore figures illustrate the same loss of appetite for development, with just 1.7ha being taken up over the 2008-09 survey period, although this is a reflection of not only the economic recession but also the extreme shortage of industrially zoned vacant land in the area. Total land availability in Albany Basin now stands at just over 32ha.

Little says the latest Manukau City survey undertaken by the Manukau City Council recorded an industrial vacancy level of 4.9 per cent, the same rate as reported in 2008. This reflects the fact that most development undertaken in recent times has been tenant-driven, with Highbrook Business Park recording the highest increase in occupied floor space over the year.

The North Shore has experienced the most marked increase in vacancy levels, up from 6.6 per cent recorded in 2008 to 9.7 per cent, the highest figure recorded by Bayleys Research since the inception of its survey in 2001.

"The sharper increase in vacancy levels north of the bridge is probably due to the fact that occupiers comprise a higher proportion of smaller companies and starter businesses which have been less able to ride out the recession," says Little.

"In addition, there has, in recent years, been a significant amount of speculative development, particularly in the office/warehouse sector."

In the short term, pressure on vacancy levels is set to continue as reduced space requirements follow staff layoffs and the running down of inventories, says Little.

"Lower levels of imports are having an impact on storage and distribution companies as wholesalers and retailers look to carry smaller stocks and to order only when required. This is resulting in companies looking to offload space through the sublease market, which will impact on rentals."

Little says a return to development activity is dependent on a lift in tenant demand which will not occur until the economy begins its recovery.

"There is still not a major over-supply of industrial property in the Auckland region and therefore a requirement for new space will arise relatively quickly once the economic cycle returns to sustained growth.

"A majority of economic commentators are forecasting economic growth to gather momentum, albeit slowly, throughout 2010. While in the short term further contraction is likely, subdued but increasing tenant demand should return to the economy in the latter part of 2010."

Bayleys Research says yields achieved on the sale of industrial property across the Auckland region have continued to soften in 2009 as investors have looked for a higher initial return from their property investment to compensate for the fact that rental and capital growth are likely to be subdued in the short to medium term.

An analysis of sales concluded during the first half of 2009 reflects a median yield of 8.9 per cent, an increase of 25 basis points over the last six months of 2008.

Little says yield increases at the prime end of the market have been relatively minor but have been much more marked for second-tier properties and it is sales in this category that are predominantly pushing the median yield higher.

"While prime and secondary properties are differentiated by a number of criteria, the primary concern for investors in the current economic climate is tenant strength. A landlord whose tenant fails is potentially facing a lengthy vacancy period and therefore investors are again looking for higher returns to reflect the greater risk inherent in purchasing properties with weaker tenant covenants."

Yields have now been softening since late 2007. From the latter part of 2008, the cost of borrowing has reduced sharply as the Reserve Bank has aggressively cut the Official Cash Rate in a bid to stimulate the economy and return confidence to the financial markets.

Little says the net result has been the re-emergence of a positive yield gap - with income returns significantly in excess of borrowing costs - which has stimulated investor interest. "With banks slashing deposit rates, the higher returns offered by property investment have attracted investor interest, particularly from syndications and high net worth individuals looking to purchase property up to $5 million."