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Money for old rope: Ageing industrial assets driving new opportunities

Supply and demand are economic fundamentals. It can be applied across multiple sectors, products, and service offerings. But when looking at real estate and Hong Kong’s topography, there’s no better demonstration of how constrained supply can support resilient demand.  

Market conditions over the last 24-months have been unprecedented and tested the resolve of real estate stakeholders. However, while some sectors have found demand to be low - albeit in a traditionally supply limited market ¬- the industrial sector has thrived and found an ideal eco-system that sees supply and demand favour owners and landlords. This is best demonstrated in the figures from Q2 that show warehouse rents increased 1.1% QOQ, contributing to a +3.5% rental rebound in H1 2021.

So, the question is why? To understand this, you need look no further than your own habits and consumer patterns. Our demand for a greater variety of better products, delivered faster, has pushed Third Party Logistics Providers to adapt, grow and innovate. The same can be said for internet services, which in turn has driven a well-documented demand for data centres. And in terms of real estate, these factors have directly pushed the need for more storage, and logistical space – enter the demand for industrial assets. 

This demand is best demonstrated with cold storage. It has become one of the most sought-after niche asset classes in Hong Kong, which has been triggered by the pandemic, robust supermarket sales and the doubling down of e-commerce food delivery, to store temperature sensitive products. In addition, the retained imported frozen food industry has also seen an increase in volume of 49% (1.6 billion kilograms) up to the end of 2020.

For anyone thinking about its impact on the retail sector in terms of numbers, one of the major winners is HKTVmall as they reached revenue of HK$2.7 billion (US$0.4 billion) in 2020, up 154% YOY.

This may seem like the industrial sector is at the start of major trajectory, but despite this high demand, supply of vacant units is very low. This has provided operators with a challenge to source, and move into good quality, fit-for-purpose units. This shows a dichotomy in the market between other sectors, such as office, where they are still nearing the bottom of the market (and in some cases bottomed out) and facing high stock levels versus low demand. 

One solution is to consider conversion from old industrial buildings. This route has had a major impact on how new operators approach this problem, and since 2016, 23 existing cold stores have been licensed with at least 16 located in typical industrial buildings. Taking on this type of a project might be a logistical threshold for some, but the current buildings are more suited than you would expect. The critical thing is to improve the thermal insulation by undergoing minor works such as thickening the floor slab or erecting a block wall. So, if there is no stock available, conversion is the next best thing.

The side bar to this, is that it aligns with the objective of the government; to utilise, regenerate, and upgrade existing industrial buildings. This includes initiatives such as the revitalisation scheme and the standard rate measure. Together, they provide an attractive opportunity for an investor to consider industrial assets, to transform the quality and purpose of old industrial assets giving these buildings a new lease of life in a sustainable way. 

Cold storage assets have become a target for investors, and most typically institutional funds. This is especially true this year as we have seen three cold storage assets change hands in the first four months of 2021, worth a total of HK$2.3 billion (US$0.3 billion). One of these major transactions was an en bloc unit where the Kai Bo Group structured a deal around a sale-and-leaseback model, selling to institutional fund Angelo Gordon. 

The takeaway is that we should always expect a fluctuation in supply and demand in real estate – even in Hong Kong. It is the understanding of the ‘why’ behind that change that can make the difference, and then being able to react. For professionals looking at industrial property, closely follow public trends as that tends to be a quick social barometer of the future usage of these assets, allowing you to anticipate what’s next, and even potentially find money for old rope.

This article was published on South China Morning Post on 13 July 2021.