Is the UAE I&L market calling out for speculative development?

12 Jan 2023

By Tomas McLaughlin, Jonathan Briggs

Low availability of suitable stock fit for needs and latent demand looking for an upgrade Is the UAE

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The UAE’s Industrial & Logistics (I&L) sector is in the spotlight, and for good reason. With recent government initiatives, and a change in demand from the I&L sector, combined with an absence of new high quality stock, CBRE sees opportunity for the entrepreneurial developer investor.

New & Increasing Demand

The logistics market should have gone from strength to strength with the increase in e-commerce, cloud kitchens, delivery 24-7-365, and rents should be climbing. The de-restriction of activities requiring a J.V. partner is enticing new entrants to the market. But we haven’t seen the market move in the way we would have expected.

While delivery services were already becoming an ever-increasing part of our lives (even pre-pandemic and especially so post pandemic), there is no doubt the newfound level of convenience has stuck. Consumers expect access to products, across the UAE, and are demanding their delivery on a reduced timescale. To cater to this, we have seen a rapid expansion in the short-term delivery services market. A solid grouping of new e-retailing, grocery, and food delivery apps have emerged, targeting shorter and shorter delivery time periods and new types of requirements, combined with an already heightened level of demand for traditional warehouse spaces, underpinned with the lack of availability, is causing frustration amongst occupiers both existing and new entrants.

In addition to the emerging last mile delivery requirements, we have seen the UAE increase its emphasis on its in country industrial and manufacturing sectors, as part of its economic diversification policies. By 2031, the UAE, under operation 300bn, is aiming to increase the size of its industrial sector’s contribution to GDP from AED 133 billion to AED 300 billion.


Limited Existing Industrial & Logistics Stock to Client Requirements

More so, the current stock does not cater to the prevailing and future expected nature of occupier demand. The market is characterised in great quantity by old, out-of-town manufacturing and trading warehouses and the supply of modern logistics warehousing accounts for a small portion of total stock, with vacant stock being minimal.

Where available, modern logistics warehousing tends to be situated in Free Zone locations close to ports/ airports which, although typical for the more traditional logistics business there, are not suited to the rapidly increasing last mile logistics market to cite one example.

In other global cities, logistics parks in urban areas have been developed to cater to the last mile delivery requirement from occupiers but the development of such assets is considerably more difficult in the UAE. Most prime greenfield sites in the UAE are zoned for commercial/residential uses with book values substantially above what can be reasonably achieved by an industrial or logistics operator when the FAR is above 1:2.

The UAE industrial market has also historically been dominated by owner-occupied warehouses with limited speculative development from investors. Where ‘build-to-suit’ (BTS) or speculative developments have occurred, they have primarily been from master developers designed to kick start activity within their respective industrial zones. These have been and remain of great success.

In particular the on-shore non-Free Zone market is under developed in comparison to the Free Zone locations. Free Zone Authorities have typically offered easier entry for end users via an affordable land lease, but the limited availability of on-shore non-Free Zone land has led to a dearth of supply at a time when it’s most needed. CBRE’s clients are looking to basement carparks for space to operate from, in other markets we’re considering all suitable properties – including residential villas and vacant retail units.

It’s undoubtable that as the UAE industrial & logistics market continues to mature, we expect the current underlying supply and demand indicators pointing toward significant and relatively untapped development opportunities in the Grade A segment of the market to continue and expand as occupiers review the modern stock and the positive attributes, the up to date health and life safety measures, the increased circulation and parking offer, and the significantly increased efficiencies when compared to their current premises. In increase in rent is likely to be offset against these attributes.

Build To Suit Vs. Speculative Development

We see developers are delaying the development of potential plots in the hope of agreeing a BTS agreement with an end user to minimise the risk and increase returns. A BTS agreement is based on the specific requirements of the occupier and the final product tends to be more specialist. Whilst this does have a cost to the developer, they will typically secure above market rental rates, 10-year leases with limited rent-free periods and fixed rental uplifts agreed throughout the duration of the lease term. However, the frequency of these requirements in addition to the number of existing developers in the market results in stiff competition when a BTS does come to the market.

CBRE is of the opinion that the market is pointing towards speculative development, and if a developer was to proceed with a speculative development, understanding that the final design will be more generic than a BTS warehouse, we see the developer’s risk to exposure to open market rents, tenant incentives such as rent free, letting voids and marketing period as well as a determination on the likely covenant strength of an incoming tenant offset by the reality of the market once the project is under construction. CBRE has seen in many cases speculative development by Free Zone Authorities leasing during construction meaning an increased returns vs the project cash flow.

We agree, that for risk averse developers, holding out for a BTS deal is the safe option but unfortunately, despite the high market demand, BTS transactions are not as frequent in the market and only a limited number of international clients will engage in these discussions. If we look at the latent demand in the market as we see it, we envisage a well located, well designed and arranged, market priced speculative development leasing during the construction period. Interesting, for existing developers and owners, the lack of speculative development to a high standard is also holding rents back as we see no new deals at new market rents setting new benchmarks for the market, resulting in increased rents in Grade B and C property.


Investment Appetite

As the UAE remained ‘open for business’ through the pandemic, a spotlight focused on the I&L sector across the region from local and international investors and funds, as a market worth investing in. This has resulted in several international hedge funds opening new offices in Dubai, and planning to deploy capital in the region. In tandem with this, the I&L asset class has sprung to the attention of local funds and investors interested in diversifying their portfolio against a backdrop of uncertainty in other sectors.

Recent transactional evidence demonstrates yields for income-producing assets in the UAE contracting to around 8-9% over the past 24 months, and with prime industrial yields globally closer to 5-6%, there is an opportunity for further contraction within the UAE as the market continues to mature.

CBRE would like to see an open market sale of a new high quality I&L property in an onshore non-Free Zone location, for a real test of market yield to occur.

The Formula For Success

Global economic headwinds appear to be doing little to stem demand from occupiers, meaning developers with immediate access to land free from encumbrances who have cash reserves or access to finance can benefit from having a market looking for stock but not being able to find it.

It is likely that the formula for success will be a joint venture between an experienced international developer and a partner with access to prime industrial land. First mover advantage will be critical, and we expect planning for a number of these schemes is ongoing. A race to market may already be underway.

After all, if you don’t build it, how can they come ?

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