Friday 28 March 2014

Coping with high industrial rents

Space is a scarce resource in Singapore, and small and medium-sized enterprises need creative solutions to cope with rising industrial rents
By Chia Yan Min, The Straits Times, 25 Mar 2014

IN 2011, the factory occupied by local fragrance maker Senses International was sold by government agency JTC to a private sector firm. Soon after, rent for the company's 7,000 sq ft space at Tai Seng was bumped up by a hefty 70 per cent.

Senses' founder Fredrik Cheng considered buying his own strata-titled factory space, but said the units the company could afford were relatively inaccessible.

"We would also have had to spend a lot of time and money shifting there," he added.

Mr Cheng's woes are common among bosses of small and medium sized enterprises (SMEs), most of whom have resigned themselves to steep labour costs as Singapore tightens the tap on foreign workers.

But that leaves them with less room to manoeuvre when it comes to another costly resource: land. According to a pre-Budget survey by the Singapore Business Federation (SBF), rents are the second most worrying cost issue for SMEs after wages. Industrial rents in particular - for instance, for warehouses and factories - have risen more steeply than office and shop rents.

In the recent Budget debate this month, costly industrial space was a hot topic. At least eight Members of Parliament rose to plead for more aid for companies.

Many blamed recent steep rental hikes on real estate investment trusts (Reits), which now own land previously sold by state agencies JTC and the Housing Board.

Reits borrow money and issue equity to buy properties to lease out, then use that rental income to pay their unit holders and lenders. They may raise rents, but they justify the increases by saying that they invest in renovation and upgrading.

"With Reits taking over most industrial and commercial premises, the cushioning effort provided by JTC in the past is totally removed," said Nominated MP R. Dhinakaran.

MP Inderjit Singh added that JTC's sale of its properties was "a huge shift, and the Government lost the ability to influence rental prices, resulting in developers and investors making the money".

Are Reits really to blame for high industrial rents? And should more be done to help SMEs cope?

Tough lease terms

THE MPs are fingering Reits because the recent jump in industrial rents coincided with JTC selling off chunks of its industrial properties in 2008 and 2011.

The move was meant to create a more vibrant market and allow the statutory board to focus on strategic industrial developments.

But it also led to rents rising. Between 2010 and 2013, industrial rents surged 51.5 per cent, compared with 22 per cent for office space and 4 per cent for shops.

JTC now directly leases out only 8 per cent of industrial space in Singapore. It owns another 45 per cent of industrial land, but leases the sites to private landlords, who build properties on the land and set rents for individual tenants.

Another 5 per cent of industrial space is owned by other state agencies such as the Housing Board.

Other private players own 26 per cent, leaving Reits with just 16 per cent of the market - hardly enough to be a price-setter.

Minister of State for Trade and Industry Teo Ser Luck said in the Budget debate that Reits must "compete in the rental market to attract tenants" - such as with attractive pricing - like any other landlord.

Still, having to deal with private landlords, including Reits, appears to have made life more difficult for SMEs.

In addition to rising rents, SMEs often have to contend with lease agreements that favour landlords, said Colliers research head Chia Siew Chuin. For instance, it is typically more difficult for tenants to terminate a lease agreement early than it is for landlords.

If their contracts do allow early termination, tenants might be required to search for another company to take over the space.

While larger manufacturers have more bargaining power because they rent more space, SMEs are typically at a disadvantage, she added.

Meanwhile, property insiders have offered other reasons for the sharp rise in industrial rents.

Rents could have been catching up to market rates, as JTC had previously subsidised rentals, said Associate Professor Sing Tien Foo of the National University of Singapore's Department of Real Estate.

Tight land supply could have been another reason for the increase in rents, said Ms Chia.

Since 2006, the occupancy rate of industrial spaces islandwide has been above 90 per cent.

JTC told The Straits Times that it has released more land to meet demand. From 2010 to 2013, it sold an average of 28ha of indus-trial land per year - more than double the annual average sold between 2005 and 2009. But land sales do not translate instantly into more industrial space because properties take time to build.

Another problem is that some land was used to build "shoebox" industrial units - some as small as 500 sq ft - to cater to property speculators. These buyers shifted their focus to industrial properties after curbs were imposed on speculation in the housing market.

But these are not usable spaces for "true blue industrialists", who typically need more space for their operations, said Savills Singapore research head Alan Cheong. Non-manufacturers may rent them instead as offices since they are cheaper.

Industrialists - mostly manufacturers - usually find suitable space mainly in properties owned by Reits, he added.

Easing the crunch

TO ITS credit, the Government has ramped up measures to rein in industrial rents. It has bumped up supply and is requiring developers of industrial land to build bigger units and more of them.

To curb short-term speculative activity in the market, a seller stamp duty of between 5 per cent and 15 per cent of the sale price has been imposed on industrial properties sold after January last year.

In addition, industrial sites with shorter tenures and smaller sizes have been released to allow more affordable developments.

Lastly, the Government has tightened rules on the use of industrial space to squeeze out tenants with non-industrial needs. As industrial premises tend to be cheaper than office and shop space, furniture makers and warehouse operators might find themselves edged out by tuition centres or travel agencies that are willing to pay higher rentals.

But now, firms taking up industrial spaces must use at least 60 per cent of the floor area of each industrial unit for "core" industrial activities such as manufacturing, assembly and repair workshops or storage facilities.

Balancing needs

WITH the help of these moves, industrial rent rises are expected to moderate this year, said property consultants.

Mr Kurt Wee, president of the Association of Small and Medium Enterprises, pointed out that the diversity of industrial landlords has contributed to a more vibrant landscape and more competition.

"It is important to maintain that diversity and not have only huge institutional landlords... Smaller private landlords tend to be more flexible and put less pressure on rents to increase. The only issue is that space is still scarce," he said.

In the meantime, it is worth noting that rental costs make up only about 6 per cent of manufacturing SMEs' costs on average, compared with 30 per cent for retailers, according to the latest Economic Survey of Singapore.

Company bosses say that while rents add to rising costs, high wages are still a bigger worry. Mr Paul Lim, managing director of Craftech Printing Services, said rent makes up 10 per cent to 15 per cent of his company's costs, while labour costs are a more significant 60 per cent to 70 per cent.

Still, the Government should continue to keep a close eye on the market. One issue is that what qualifies as "industrial use" is more fraught with ambiguity.

"A lot of our manufacturing firms are moving up the value chain, and much of their activities might no longer be in manufacturing, so they may drop below the percentage required for industrial space occupation," said Mr Victor Tay, SBF's chief operating officer.

For instance, firms might diversify their businesses to carry out research and development.

Clamping down on users that fall into this regulatory grey area raises the question of where they should go, as normal offices may be unsuitable or too pricey.

The median cost of industrial space was $23 per sq m monthly at the end of last year, compared with $101 for central area offices, $44 for fringe area offices and $80 to $95 for shops, according to government statistics.

To address this, the Government can consider forming clusters in some industrial estates, where relevant firms can rent space even if they do not meet minimum industrial use rules.

The Government can also play a bigger role in helping SMEs obtain more equitable rental terms from landlords. The SBF has called on the public and private sectors to develop a standard tenancy agreement to be used across the board. This would help level the playing field for tenants.

Another possible avenue is to encourage land intensification among SMEs, through the use of rental rebates, grants or tax allowances. While productivity boosting measures such as automation and training come with a slew of rewards, schemes that reward SMEs for efficient use of space are sorely lacking in comparison.

The Land Intensification Allowance is one of the few such schemes. It allows companies to claim for spending incurred when they build properties that meet a certain land use intensity. Any company that builds or modifies its properties can qualify.

Implemented in 2010, the scheme was extended for another five years in this year's Budget, and expanded to cover the logistics sector as well as businesses carrying out qualifying activities on airport and port land.

While the scheme is a move in the right direction, it covers only selected sectors, such as pharmaceuticals and petrochemicals. A broader scheme that covers more sectors, and offers cash payouts or rental rebates rather than tax incentives that favour larger firms, is likely to make SMEs more enthusiastic about looking for creative space solutions.

But the fact remains that space in Singapore will remain scarce and expensive, and bosses such as Mr Cheng will have to adjust to elevated rents.

"It is very difficult for small companies now, not to mention new entrepreneurs," said Mr Cheng, who has been travelling in Malaysia, Thailand and Taiwan in search of possible alternative factory locations. "In the long term, we have to think really hard about whether our factory should be located here or elsewhere."

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