The combination of greater funding, technological advancements, and impacts of the pandemic are directly impacting local manufacturing, which is flowing onto industrial real estate. Michael Raymond from LPC explains what this means for business.
Australia has had a proud manufacturing history. In fact, cities were established and thrived off the back of manufacturing plants in the 1950s and 60s. They provided employment for many of Australia’s new arrivals leaving war savaged Europe.
However, by the 1970s Asia began to emerge as a more cost effective solution for manufacturers. This led to the off-shoring of manufacturing, which had traditionally been undertaken domestically. Sadly, this trend resulted in the closure of a number of Australian institutions.
Could this be about to change? There are two strong factors which indicate that this might be the case.
Firstly, the manufacturing sector has embraced technology and innovation.
While not necessarily a recentdevelopment, technological advancements are becoming more cost effective, enabling manufacturers to adopt new processes.
Artificial Intelligence (AI), robotics, and automation are now becoming more prevalent and perhaps even the norm rather than the exception. Their adoption has led to Australian manufacturers becoming more cost effective.
The second factor is the impact and effects of Covid.
The pandemic caused significant disruption to international supply chains, highlighting to those reliant upon overseas production facilities how quickly everything could go wrong.
The backlog of product continues to be a problem as we emerge from the pandemic and enter the “new normal”.
Coupled with the more cost-effective landscape, is there an opportunity for Australian manufacturers to consider onshoring?
Indeed, the Federal Government has identified this and through its Modern Manufacturing Initiative is providing grants to companies looking to grow and expand their domestic capabilities.
For LPC, the question is, where does real estate fit in the new manufacturing world?
The Australian industrial real estate sector is booming. There has never been a more buoyant period in history. Industrial land values across Australia have increased significantly over the past 24 months. In some areas land values doubled over the period.
This is a global phenomenon driven by our changed buying habits due to the pandemic and the huge increase in online purchases. In turn, this has led to a rapid increase in demand for warehouse space. The demand for space has outstripped supply and it is basic economics that this will push land prices upward.
Manufacturers that own and occupy their land may have an opportunity to realise this uplift in value and re-direct that capital into core business. There are a number of potential strategies that an owner occupier could adopt. My focus here is on the option of a sale and leaseback.
A number of clients we are advising have, or are seriously considering, adopting this strategy, taking advantage of the strong industrial market.
A sale and leaseback transaction is when a company (the seller) sells its property to another company (the buyer). The buyer then becomes the landlord, and the seller leases the property back from the buyer, becoming the tenant.
Entering into a sale and leaseback transaction enables the seller to immediately receive funds from the buyer by selling the asset, while retaining the right to use the asset.
There are a number of potentially beneficial reasons to consider a sale and leaseback for an industrial property.
1. Capitalise on the strength of the Australian industrial property market
Australia industrial properties, like the rest of world, are in high demand. Properties with existing long-term leases and good quality, reliable tenants are most desirable. As a result, yields have been tightening and these properties, are achieving sub-5 per cent yields. (The yield is calculated as the return the current rent of the property based upon the purchase price paid by the investor.) So, as yields tighten and go down, sale prices go up.
2. Unlock capital and reinvest it into your business
Real estate is a valuable, relatively liquid asset and through a sale and leaseback you can unlock that value to re-invest directly into core business needs such as new fit-out, technology, warehouse managements systems, AI, and robotics. The big advantage of a sale and leaseback is that all of this can happen in a relatively seamless manner as you don’t have to relocate, thereby avoiding the business interruption associated with a relocation.
3. An alternative to conventional financing
The equity in your property on the back of the growth in the industrial market is likely to have increased in the past few years. A sale and leaseback is an effective tool as a means to raise capital in a relatively simple manner and as an alternative to the more traditional debt funding route.
In conclusion, there are a few words of caution.
A sale and leaseback may not be the solution in all cases. For example, there would be little point in entering into a sale and leaseback if your current property is old and dysfunctional and unable to be re-configured to suit your growing and/or changing needs. It may be more appropriate to realise the uplift in value of the land and lease a new purpose-built facility. This would enable you to utilise the proceeds from the sale for new plant, equipment, technology, and systems in a new facility.
It’s also important to consider the lease structure in conjunction with the agreed commercial terms. Keep in mind that you will need to comply with the lease for possibly the next 10-15 years.
There is a need to strike a balance with the lease terms in order to make it attractive to an investor whilst being financially and commercially sustainable for your business operations.
This article first appeared in the May 2022 edition of Food & Drink Business.
