The UAE’s industrial and logistics (I&L) sector is in the spotlight, and for good reason. With recent government initiatives, and a change in demand from the sector, combined with an absence of new high quality stock, CBRE sees opportunity for the entrepreneurial developer-investor.
Sharply rising demand
The logistics market should have gone from strength-to-strength with the increase in e-commerce, cloud kitchens, delivery 24x7x365, and rents should be climbing. The de-restriction of activities requiring a JV partner is enticing new entrants. But we haven’t seen the market move in the way we would have expected.
While delivery services were already an ever-increasing part of our lives, there is no doubt the newfound level of convenience has stuck. Consumers expect access to products, across the UAE, and are demanding their delivery on a reduced timescale.
To cater to this, we have seen a rapid expansion in the short-term delivery services market. A solid grouping of new e-retailing, grocery and food delivery apps have emerged, targeting shorter and shorter delivery time periods and new types of requirements. This is combined with an already heightened level of demand for traditional warehouse spaces, underpinned with the lack of availability, is causing frustration amongst occupiers both existing and new entrants.
We have seen the UAE increase its emphasis on its in-country industrial and manufacturing sectors. By 2031, the UAE, under ‘Operation 300bn’, is aiming to increase the size of its industrial sector’s contribution to GDP from Dh133 billion to Dh300 billion.
The current stock does not cater to the prevailing and future expected nature of occupier demand. The market is characterised in great quantity by old, out-of-town manufacturing and trading warehouses and the supply of modern logistics warehousing accounts for a small portion of total stock, with vacant stock being minimal.
Where available, modern logistics warehousing tends to be situated in free zone locations close to ports/airports which, although typical for the more traditional logistics business there, are not suited to the rapidly increasing last-mile logistics market to cite one example.
In other global cities, logistics parks in urban areas have been developed to cater to the last-mile delivery requirement from occupiers. But the development of such assets is considerably more difficult in the UAE. Most prime greenfield sites in the UAE are zoned for commercial/residential uses with book values substantially above what can be reasonably achieved by an industrial or logistics operator when the FAR is above 1:2.
The UAE industrial market has also historically been dominated by owner-occupied warehouses with limited speculative development from investors. Where ‘build-to-suit’ (BTS) or speculative developments have occurred, they have primarily been from master-developers designed to kickstart activity within their respective industrial zones. These have been and remain of great success.
The on-shore non-Free Zone market is under developed in comparison to free zone locations. Free zone authorities have typically offered easier entry for end-users via an affordable land lease. But the limited availability of on-shore non-free zone land has led to a dearth of supply at a time when it’s most needed.
CBRE’s clients are looking for basement car park space to operate from, in other markets we’re considering all suitable properties – including residential villas and vacant retail units.
It’s undoubtable that as the UAE industrial and logistics market continues to mature, we expect the underlying supply and demand indicators pointing toward significant and relatively untapped development opportunities in the Grade A segment of the market to continue and expand as occupiers review stock, the up-to-date health and life safety measures, increased circulation and parking offer, and the significantly increased efficiencies when compared to current premises. An increase in rent is likely to be offset against these attributes.
We see developers are delaying the development of potential plots in the hope of agreeing a BTS agreement with an end-user to minimise the risk and increase returns. A BTS agreement is based on the specific requirements of the occupier and the final product tends to be more specialist.
Whilst this does have a cost to the developer, they will typically secure above market rental rates, 10-year leases with limited rent-free periods and fixed rental uplifts agreed throughout the duration of the lease term. However, the frequency of these requirements in addition to the number of existing developers results in stiff competition when a BTS does come to the market.
CBRE is of the opinion that the market is pointing towards speculative development. And if a developer was to proceed, understanding that the final design will be more generic than a BTS warehouse, we see the developer’s risk to exposure to open market rents, tenant incentives such as rent-free, letting voids and marketing period as well as a determination on the likely covenant strength of an incoming tenant offset by the reality of the market once the project is under-construction.
We has seen in many cases speculative development by free zone authorities leasing during construction, meaning an increased returns vs the project cashflow.
We agree, that for risk-averse developers, holding out for a BTS deal is the safe option. Unfortunately, despite the high demand, BTS transactions are not as frequent in the market and only a limited number of international clients will engage in these discussions. We envisage a well-located, well-designed and arranged, market-priced speculative development leasing during the construction period.
Interesting, for existing developers and owners, the lack of speculative development to a high standard is also holding rents back as we see no new deals at new market rents setting new benchmarks for the market, resulting in increased rents in Grade B and C property.
As the UAE remained ‘open for business’ through the pandemic, a spotlight focused on the I&L sector across the region from local and international investors and funds, as a market worth investing in. This resulted in several international hedge funds opening new offices in Dubai, and planning to deploy capital in the region.
In tandem with this, the I&L asset class has sprung to the attention of local funds and investors interested in diversifying their portfolio against a backdrop of uncertainty in other sectors.
Recent transactional evidence demonstrates yields for income-producing assets in the UAE contracting to around 8-9 per cent over the past 24 months, and with prime industrial yields globally closer to 5-6 per cent, there is an opportunity for further contraction within the UAE as the market continues to mature.
CBRE would like to see an open market sale of a new high quality I&L property in an onshore non-free zone location, for a real test of market yield to occur.
Formula for success
Global economic headwinds appear to be doing little to stem demand from occupiers, meaning developers with immediate access to land free from encumbrances who have cash reserves or access to finance can benefit from having a market looking for stock but not being able to find it.
It is likely that the formula for success will be a joint venture between an experienced international developer and a partner with access to prime industrial land. First mover advantage will be critical, and we expect planning for a number of these schemes is ongoing. A race to market may already be underway.
After all, if you don’t build it, how can they come?