Overcoming structural demand and new supply mismatch of industrial properties

By Ong Kah Seng,

Alex Sun

/ R'ST Research, The Edge Property |

July 22, 2015 9:00 AM SGT

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Industrial properties, specifically strata factories and single-owner modern factory buildings, have been facing headwinds in rents and prices, since 2014.

Gone were the days also, when strata factory units were quickly snapped up by investors, including the mom-and-pop investors who were eager to invest in any property during the low interest rates period, especially in 2011-2013. The current sombre mood for industrial property investments is a stark contrast compared to around 2011, where new modern factory units were massively rolled out by developers for sale.

There is generally low take-up of the newly completed factory projects, resulting in glaring vacancies even the projects were of impressive, modern design. As such, the factory projects which were recently completed, showcase the sophisticated hardware, but lack in the software, that is industrialists-tenants’ interest and development vibrancy. Most newly completed projects were unable to achieve the envisaged vibrancy, rendering some of the specially designed common development amenities and project’s X-factor designs fairly redundant.

Cooling measures not the only thing dampening industrial property prices

In Jan 2013, the Sellers’ Stamp Duty (SSD) for industrial properties was introduced, to minimize speculations and overheating of industrial properties. In end June 2013, the Total Debt Servicing Ratio (TDSR) was introduced for all property financing. Consequently, industrial property buying interest plummeted and prices moderated notably.

One therefore quickly points to the works of the cooling measures, which resulted in dampening of buyers’ interest for industrial properties. However, we should note that the measures were mainly aimed at reducing speculative froth, and investors were generally not discouraged from buying factory units should they have the proper affordability. It seems two years after the implementation of the cooling measures, investments in factory units became fairly passé, reinforcing that there are stronger reasons underpinning weakened factory investments than merely the works of the cooling measures.

If indeed factory units are still value investment propositions, investors with the affordability will continue doing so as the cooling measures generally target at flipping of factory units. New completions offering modern designs generally see limited tenants’ interest, and it therefore reflected that such newly completed units asking for rental premiums might have exceeded tenants’ willingness to pay and their affordability. It could even be spatial products that were developed in excess of tenants’ practical requirements.

Weak leasing demand for new completions meant the frills are ‘indeed frills’

It is quite a new confirm trend on how industrialists (both buyers and tenants) are unlikely to buy into premium factory products, especially newly completed space or those in up-market or central locations. Industrialists are seen to be very cost-sensitive by now, as we can see that the new factory completions generally did not attract much industrialist/tenants leasing interest. There is actually no mileage for industrialists to occupy modern, frills-filled factory space, because end of the day, it is still manufacturing space and perhaps the industrialists generally prefer to focus more on developing their products.

Functionality and cost-efficient (older) space in fact seem to be better received by industrialists, especially those which are able to cut rents to attract tenants. There may be strong marketing points about factory space in well-positioned localities like eastern part of Singapore, or for newly completed and modern factory space, but a very key area that was overlooked by investors and landlords is that there is a limit as to how much mileage on occupying factory space can have for industrialists – after all industrial properties are lowest rung among all property types (including residential and office) - so the brick and mortar image persists for factories.

Industrialists generally still prefer to have a place at practical costs, meeting their technical production requirements and focus more on their products amid the intensified manufacturing competition with key lower-cost countries in the region (Asia). In fact, many conventional manufacturing industrialists are small, medium enterprises (SMEs) who even rely on a whole bundle of government assistance and grants, incentives, to lower their operating cost. A new factory space asking for rental premium cannot be justified by SMEs. Unless the property frills and modern design come at minimal costs (rents), only then industrialists will be willing to pay for leasing them – that is why new factory space completed in recent times generally fetch some $2 psf per month, instead of a targeted $3 psf per month rental, the latter which severely exceeded industrialists’ affordability threshold.

Weakened land bidding interest reflective of developers understanding tenants are not willing to pay premium for frills

In the latest industrial Government Land Sales (iGLS) 2H 2015, 5 sites in Tampines Industrial Drive were put on the Confirm List. There will be on-going demand by industrialists, contractor-developers, or even developers - but the bidding interest is expected to be cautious. In May 2015, Plot 4 at Tampines Industrial Drive drew weak bidding interest – only 3 bids, where top land bid was only $68.85 psf ppr. In Jan 2015, the tender for Plot 8 at Tampines Industrial Drive drew only 4 bids – and this was already considered fairly lukewarm response by developers.

The recent weak developers’ interest for Plots 4 and 8 at Tampines Industrial Drive showed that industrial property sentiments (among buyers, investors and developers’ interest) has deteriorated so significantly – so, even Tampines Industrial Drive sites which are considered to be at the well-positioned, well-located eastern part of Singapore, are expected to receive limited developers’ interest. Developers more or less noticed the trend where investors and end-users are unwilling to pay premiums for new factories that are well-design, so they are not bidding aggressive for the land anymore.

All sites are of a maximum of 30 years, in fact around 20 years tenure. These short leases meant diminishing asset value life, and limited investment potential. It is more relevant for end-users (industrialists) who simply need to own their production space instead of renting it, as renting their production space will not allow them to have certainty over rental costs as lease renewal rents are subjected to prevailing market conditions.

Innovative leasing strategies to overcome industrial property headwinds

Other than the impacts arising from surge of new factory space that will be completing in 2015 and 2016, we must recognize that there is a severe structural mismatch in users’ demand and supply. The modern factories which were conceptualized and marketed actively in 2011-2013 as cutting edge, trendy strata units, offered frills which industrialists generally do not require and are unwilling to pay rental premiums for. Most industrialists prefer space in fact older premises that is cost-effective; so long it meets technical requirements for production processes.

But all may not be lost for investors who bought into new strata factories which recently completed, or will be completing. They can always lower their rentals substantially to attract industrialists for the initial investment term, that is, the first 2-3 years. Ideally, if the investor rent the space at very attractive rates to budding or small scale industrialists, who ultimately enjoyed this platform for future business expansion, it will add meaning to both the landlord and the users. When time is up for lease renewal, the industrialists might have grown stronger financially and can renew leases at higher rents. Investors who found it very hard to rent out their new premises can work closely with SMEs and associated parties, to give priority to small-scale industrialists with promising growth potential. Landlords of new completions can also consider giving the small industrialists more rent-free months, including arranging for different small businesses to co-share space or a unit. When the budding industrialists grow at their premises, or that development, it will add intangible value and accolades for the property owners.

Strategic, wider thoughts on industrial property relevance

On the providing of land by the state for industrial property development, we must always bear in mind that there’s competing users for each site in ‘land-scare’ Singapore, and Singapore’s key concerns are to provide sufficient housing and land for commercial uses where commercial activities are our main pillars for economic growth.

Industrial properties must be provided for sufficient users’ (industrialists) needs, at affordable prices - but an oversupply is definitely to be minimized considering industrial property land use is still secondary compared to other competing land uses.

As a global city, we are also focusing on financial viability and industrial activities will surely trend towards high value-added systems or support for retail distributions (e.g. logistics for online retailing), although there is continued relevance to cater to humble industrialists who focus on conventional manufacturing for a living. The government therefore remains very dedicated in providing sufficient land for various types of industrial development, but demonstrate precision in downplaying risks of oversupply in the recent iGLS programmes.

This article appeared in The Edge Property Pullout of Issue 686 (July 20) of The Edge Singapore.

Ong Kah Seng is a director and Alex Sun is a senior analyst at R'ST Research. The views expressed here are their own.

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