Has Industrial Peaked? Rental Growth Stagnant Amid Rising Vacancies, Says Savills Report

Australia’s industrial property boom may have finally reached its peak, according to leading real estate agency Savills Australia’s recently released ‘Spotlight Industrial Shed Briefing – July 2024’ report.

The report revealed that industrial vacancy rates are climbing on the East Coast – reaching 3.4% in July – while rental growth slows to a standstill across most core markets.

But according to Savills, investment activity remains robust with total investment volumes exceeding $3 billion in Q2. While reflecting a modest increase of 8% from Q1, it’s a whopping 168% greater than its lowest quarter last year – and driven partially by Barings and REST Super’s recent $780 million acquisition from Goodman Group.

While this points to investors’ continued appetite for industrial, Savills says we may be closer to the cyclical bottom than previously thought.

The Shed Briefing has also revealed leasing activity is at pre-pandemic levels – with 767,875 square metres of industrial space leased in Q2. This reflects a 20% increase from last quarter.

“We are certainly navigating the start of a new chapter for industrial property – with vacancies creeping upwards coupled with rental growth slowing, despite high levels of investment. While the continued high interest rate climate and uncertain economic outlook combine to create further challenging conditions for the sector, the outlook is positive on the back of the enduring themes related to population growth and shifting supply chains,” said Savills’ National Head of Research, Katy Dean.

Rental Growth Stalls as Vacancies Increase

While 2023 saw rental growth in some precincts peaking at nearly seven times their average, a very different trend is now unfolding, says Savills. Nationally, prime net face rents remain 62% higher than they were in 2019, but the outlook for further rental growth has narrowed – especially in markets where vacancy has risen.

“Rental growth has ground to a halt in the country’s core precincts, including Melbourne West, Brisbane Southside, and Adelaide Northwest. A select few areas are now seeing rents contract. For example, prime net face rents in Sydney’s West have declined 7% quarter-on-quarter,” said Ms Dean.

However, she noted that despite this decline, Sydney West rents remain 84% higher than they were five years ago in Q2 2019.

Vacancy rates have also risen across the East Coast, reaching an average of 3.4% in July 2024 – up from 2.8% in March, according to the Shed Briefing. Sydney’s increase in vacancy is most notable at 3.62%, up from 2.2% in March, while Melbourne’s vacancy has risen to 3.07%, up from 2.72%. Brisbane’s vacancy is relatively stable at 3.38%, compared to 3.47% in March.

Interestingly, Ms Dean said that leasing incentives have gradually increased since mid-2023, continuing into Q2 2024 and leading to a decline in net effective rental rates.

“If effective rents continue dwindling due to higher incentives, there may be a real adjustment to capital values, which – up until this point – has been shored up by face rental growth as yields hold. While there has been no sign of this correction in Q2, we may start to see this divergence if there is a greater spread of precincts seeing effective rents decline,” she said.

Investors Show Continued Appetite for Industrial

However, despite the slowdown in rental growth and uptick in vacancy rates, strong off-market activity shows that investor confidence remains robust. The most significant investment deal of Q2 is Barings and REST Super’s joint acquisition of a 12-asset portfolio from Goodman Group, totalling approximately $780 million.

Michael Wall, National Head of Industrial and Logistics at Savills said: This investment underscores an embedded confidence among investors, driven by accelerating demand factors such as sustained population growth, e-commerce expansion, and enhanced supply-chain resilience.

“The shift in appetite that we’ve seen over the last 12 months from super and sovereign wealth funds reaffirms investor preference for the sector.

“Notably, rising allocations towards industrial logistics away from other asset classes not only serves as a hedge against volatile economic conditions but also positions them to capitalise on the structural changes that are happening on the back of population growth. This trend is evident as more groups begin land banking, especially in Melbourne and Sydney.

“Although rental growth in most markets is decelerating, there remains significant potential for rent reversion, with current rents averaging about 60 percent higher than they were five years ago, presenting a compelling windfall to investors looking to increase their exposure.

Wall said while vacancy rates have ticked up recently, they are still low relative to historical levels. With developers taking a more controlled view on their development pipeline there remains material upside to demand generation, particularly once debt costs come back a bit.

Savills’ report reveals that total investment volumes reached approximately $3.1 billion in Q2, for deals with a sale price of $10 million or above. This represents a small increase of 8% from Q1, but a staggering 168% increase from Q1 2023, its lowest quarter last year.

“Increased deal flows in the last quarter suggest that the gap between buyer and seller expectations may be narrowing, and the industrial sector’s protracted period of price discovery is approaching its peak. Ongoing deal activity suggests that we may be closer to the cyclical bottom than previously thought,” said Ms Dean.

While the continued higher interest rate environment is driving caution, private investors, syndicators, and owner occupiers remained active in the $10-to-$50-million price bracket – accounting for 47% of deals tracked in Q2.

Last Mile Tenants Dominate Leasing Activity

According to Savills, around 767,875 square metres of industrial space was leased across Australia in Q2, including pre-commitments – representing a 20% increase from Q1. This is now on par with pre-pandemic leasing activity, which averaged around 700,000 square metres per quarter from 2016-2020.

However, the retraction could reflect a response to continued economic uncertainty, according to Ms Dean.

“While current leasing activity could be a sign of market normalisation, it could also reflect tenant demand adjusting to short-term economic pressures, such as high inflation, reduced household spending, and tight financing conditions,” said Ms Dean.

Savills report revealed that transport and logistics tenants are driving leasing activity on the East Coast, taking up 44% of industrial space over 3,000 square metres. This was followed by wholesalers, accounting for 33% of take-up, and manufacturing and engineering, which accounted for 13%. The total share of leasing take-up from transport, logistics and wholesalers has grown to 78% in Q2 – up from a low of 70% last year.

Industrial Outlook: Prime Rents and Vacancies State by State

In blended terms, Sydney saw prime net face rents dip by 1.8% over Q2, driven by a 7.1% decrease quarter-on-quarter in Western Sydney, and a 6% decrease quarter-on-quarter in the Southwest. Vacancy rose to 3.62% in July, up from 2.2% in March, while blended prime and secondary market yields softened by 15 basis points to an average of 5.2% and 5.7%, respectively.

Prime rental growth rates are moderating in Melbourne, slowing to 3.9% quarter-on-quarter in blended terms. Prime rents held steady in the West and Southeast, while the East rose by a whopping 13.4% quarter-on-quarter.  Vacancy rose from 2.7% in March to 3% in July, while market yields remained stable, holding at 5.3% for prime and 6% for secondary.

While most precincts in Brisbane held stable, prime rents decreased by 6.4% in the West, where vacancy is the highest, and increased by 3.7% on the Trade Coast (+3.7%), where vacancy is the lowest. Brisbane’s Trade Coast also saw a 6.7% increase in secondary rents due to undersupply. The vacancy rate for existing buildings declined to 3.38% in July – down from 3.47% in March – while average prime market yields remain unchanged at 5.7%.

Adelaide’s prime net face rents remained steady in Q2 but are showing an average increase of 4% year-on-year, with rents in the Inner West growing by 8% year-on-year. Secondary net face rents were also unchanged however Adelaide’s Southwest saw rental growth of 8.6% over the same period. Prime market yields averaged 6% in Q2, while secondary yields have held at an average of 7% over the last 12 months.

In contrast, all precincts in Perth saw an increase in prime net face rents, driven by upward pressure on economic rents in new buildings, rather than the churn of existing floorspace. On a blended basis, they rose 4.9% over the quarter – with Perth South rising by 7.7%, Perth East by 5.3% and Perth Core by 3.2%. Prime market yields have also held stable at an average of 6.2%, with secondary yields unchanged.