Industrial property: This year’s dark horse?

Industrial property – a less glamorous and often neglected asset class that includes business parks, high-tech industrial space, factories and warehouses – has been thrust into the limelight in Singapore following its stellar performance in the first quarter of the year.

According to the Urban Redevelopment Authority, the sector clocked rental and capital value gains of 6.3 and 8.3 per cent, respectively, from the previous quarter, outpacing the major property classes of office, retail and residential.

Moreover, sales of strata-titled units – which allow for ownership of individual levels as opposed to entire buildings – have recently generated good response from investors and set new benchmark prices of S$550 to S$800 per sq ft (psf).

This leads us to the question: What has been behind the strong performance and is it sustainable? We see a strong case for the affirmative.

Robust industrial production

We believe one of the main drivers of the healthy demand for industrial property has been Singapore’s robust factory output growth. While it has tapered off from the strong pace last year, industrial production is still growing at an impressive rate, rising 22 per cent from a year ago in March.

The recent signs of better economic growth in the United States should also filter through to Singapore over the next few months, and this bodes well for further growth in the industrial sector here.

Already, the sector’s strong performance over the last two quarters has led to improved demand for industrial space. For example, factory space demand (net of new supply) improved from a negative 26,500 sq m in the third quarter of last year to a very positive 105,400 sq m in the first-quarter of this year.

Spillover effects

In addition to robust industrial production, we are also starting to see office rental demand spilling over to business park spaces, which are considered higher-end industrial properties.

The strong office sector recovery last year has significantly widened the gap between office rentals in city areas and business park rentals in suburban areas, which can serve as locations for ancillary offices.

Currently, the prime office rental of around S$9.00 psf is more than double the business park rental of around S$3.50 to S$4.00 psf. This has driven some office tenants to relocate from the more expensive city spaces to the cheaper suburban locations. This spillover phenomenon was also seen during the last office rental upcycle of 2006 to 2008 and we believe it will continue to drive up business park rentals this year.

But the spillover is not just from the office segment. After harsh measures were introduced by the Government in January to cool the residential market, investors are starting to switch out of residential to industrial property, which has not been exposed to similar measures so far. Industrial property investors, for example, are currently spared from the onerous seller’s stamp duty of as high as 16 per cent.

Good yield, favourable supply

Furthermore, the recent launches of smaller strata-titled industrial units (around 1,000 to 1,200 sq ft) have made the asset class more affordable to a wider range of investors. The current industrial rental yield of around 5 to 7 per cent also looks attractive to many investors, even after adjusting for the sector’s shorter land leases, typically 30 to 60 years versus 99 years for offices.

We believe these factors underpinned the overall good sales response to the new strata projects – including UB.1, Oxley BizHub and One Pemimpin – which set new benchmark prices of around S$550 to S$800 psf for this property asset class.

On the supply side, Singapore’s industrial property pipeline currently looks benign at around 10 per cent of available stock. This is at the low end of the sector’s historical pipeline of 8 to 14 per cent and is also lower than the current office pipeline of 14 per cent of available stock.

Positive outlook

Given this confluence of supportive demand drivers and benign supply conditions, we believe the recent strength in the Singapore industrial property sector should be sustainable for the remainder of this year. In fact, we see a good chance that this often-neglected asset class could turn out to be the proverbial “dark horse” of the property sector this year, edging out the perennial favourites.

By Tan Chin Keong – an analyst at UBS Wealth Management Research

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