Dearth of land risks industry loss to Australia

'Industry needs land - it can't be intensified with many layers on one site like residential can.' - Paddy Callesen.

Auckland's industrial market has the same problems as the residential market - not enough land, high building costs and lean margins that make development unattractive, says Paddy Callesen, joint managing director of Savills.

"Conditions in the industrial market are the tightest they have been for more than a decade and supply is not keeping up with demand," Callesen says.

"While the development pipeline is improving, high land and building costs are putting the city at risk of losing business to other major Australasian cities. Australia has lower land and building costs and higher development margins than Auckland."

Callesen says there is not much that can be done about building costs, but a big increase in council-zoned industrial land supply would put the brake on rising prices and make speculative development attractive again because the margins would outweigh the risks involved.

"We can do something about land prices. We live in a country that is as big as the UK in terms of land area, but we have councils that want to squeeze cities and towns into tight boundaries when there is no need to - industry needs land, it can't be intensified with many layers on one site like residential can."

Callesen says it is frustrating for developers, investors, tenants and owner-occupiers, when there is little choice.

He says he knows of a 130-140 ha Puhinui property, ideal for industrial development near the south-western motorway that has been waiting for a plan change for seven years. "The council has apparently said the plan change can't be approved until it can marry it in with the council's own timing of the new Unitary Plan for development of the entire area."

Callesen says the council is "hammered at every opportunity" about the release of more industrial zoned land but nothing happens. "The way this can be fixed is by colouring a map showing where industrial land can be established and leaving it up to developers to produce the product. Land prices will come down and there will be an adequate supply of land for more than a decade or more.

"It will take away the artificiality of the current market and create industrial precincts that can be zoned in tandem with housing supply. Businesses are going to move to where they have a labour force and there are amenities.

Callesen says he recently had an inquiry from a wealthy Melbourne investor who wanted a one hectare site for a 5000 sq m industrial development for a tenant coming across the Tasman. "When we identified land options at $350 per sq m, he jokingly said that he 'wanted the land in the industrial areas, not in Auckland's CBD'."

Callesen says the city's high costs are leaving developers with a skinny eight per cent margin, while developers in Australia's biggest cities are securing 21 to 30 per cent margins.

Paddy Callesen of Savills.

Savills' Australasian Industrial Composition Table shows Auckland has the highest development input costs of any of the main cities, compensated only by low capitalisation costs and relatively high rents.

The table is based on a 10,000 sq m warehouse sitting on a 20,000 sq m site with a seven year lease and shows the value of the property in different cities, taking into account the land and building costs and rent.

It shows Auckland's land price for the development is $350 per sq m, building costs are $1000 per sq m, and the capitalisation rate for the completed development at 6.5 per cent and anticipated rent at $120 per sq m.

In Melbourne the land price is $200 per sq m, building costs $500 per sq m, the 'cap' rate seven per cent and expected rent at $85 per sq m. Sydney's land price is $325 per sq m, building costs $700 per sq m, a cap rate of 6.75 per cent and rent of $115 per sq m.

Callesen says while Auckland's industrial land prices remain so high or unless rents increase further, Auckland developers can't extract bigger margins.

However, he says Australia's higher development margins can be a mirage. "While capitalised rent indicates much higher development margins, what is often left out of the equation is the level of inducements or incentives given to a tenant to sign a lease.

"Melbourne, for example, offers lease inducements of 20 to 30 per cent, meaning a tenant signing a 10 year lease can expect two to three years rent free. By comparison, Auckland landlords are offering inducements of just one month for every two years of a lease term, so on a 10 year lease five months' rent freeis a four per cent inducement."

Callesen says Auckland has a low risk leasing profile as vacancy rates are close to zero. Tenants are finding it difficult to compete with owner occupiers who can pay a premium to secure premises for their businesses and spread the mortgage payments over a long period.

"The intense pressure on the market is exacerbated by speculative development coming to a virtual standstill. Before Auckland's tightening land supply and rampant rise in building costs, a 20 per cent margin was acceptable for developers. Speculative building was normal, but it is now nearly non-existent apart from developers who have land they bought some time ago."

He says smaller and medium size developments are being put on the back burner because of land and building costs and also Auckland Council's and Watercare's high development service charges.

"Speculative building on land bought in the past year would be suicide for most developers. If a speculative development sat around for more than 12 to 18 months any margin disappears.

"Tenant pre-commitment at increasingly higher rents is the only way developments are coming off the drawing board. Skinny development margins make it too difficult to go ahead with projects otherwise."