How will increased defence spending impact the industrial market?

This month Rachel Reeves outlined economic plans she said would make Britain "a defence industrial superpower".

The Chancellor argued in her Spending Review that "a new era in the threats that we face demands a new era for defence and security" as she confirmed that spending would rise to 2.6% of gross domestic product by April 2027.

The £11 billion increase, the biggest real-term rise in defence spending since the end of the Cold War, came a week after Defence Secretary John Healey unveiled proposals to build at least six new munitions factories across the country.

At the same time as ramping up protection, the government intends for the funding to help encourage economic growth, with a number of sectors set to feel the trickle-down effect from government contracts.

CoStar News spoke with warehouse specialists in the UK and mainland Europe to assess how the industrial and logistics sector could benefit from the increased spending and what areas of the UK could experience a rise in take-up and development.

Tim Crighton, head of logistics and industrial, EMEA, at Cushman & Wakefield, says the ongoing conflict in Europe and challenges in the Middle East have created a "heightened awareness" of the defence sector in the warehousing industry.

Crighton tells CoStar News that he has seen a raft of defence-related businesses lodging enquiries for industrial and office accommodation in the last few months in the UK and in mainland Europe.

An analysis by CoStar's senior director of market analytics Mark Stansfield showed the defence sector is already having an effect on the South East office market, with large deals revealed by CoSar News in Reading and and, in particular, its Green Park campus, improving take-up.

Crighton adds that increasing activity from defence-related businesses is starting to feed through into industrial and logistics requirements, with defence technology firms and companies working to "counter bad actor activity" seeking space.

"We've started to see the impact of that through the likely and normal candidates that are involved in defence as a sector, whether that is in office-related activities or production and manufacturing. The logistics side of it is something that is less overt."

Crighton argues that the manufacturing side of the warehouse sector is likely to be more affected by the government's decision to increase spending on defence and predicts activity will centre around existing Ministry of Defence sites, such as the Royal Air Force base at Brize Norton in Oxfordshire and Abbey Wood in Bristol, a Ministry of Defence site.

Crighton says the "tentative requirements" he has seen have been around the 50,000-100,000-square-foot mark. "The supply chains for the armed forces work in a slightly different way," he says.

"Because of that, a lot of [activity] is going to be around clustering of talent and technology. Some of those enquiries that we've seen, like the new start-ups coming into the market, have been clustered around some of those locations."

He adds that built-to-suit facilities are the preferred choice of building for defence manufacturing facilities used by the government and says it will be interesting to see how the government approaches its target of building six planned munitions factories and if that involves the private sector.

Crighton says that investors face a quandary in how they handle work around relating to the defence sector and their ESG goals, but says there has been progress on this since the annual Mipim conference in March.

"Defence, as a sector, can be viewed in two ways from an ESG perspective. One is that conflict is horrendous we should avoid it all costs, which I think is a sensible position.

"However, you could also argue that in defence, protection of the realm is the core fundamental for government and, therefore, the S of ESG is arguably [linked to] social protection. So you could view that I think in a couple of different ways."

"The reality is that global capital flows don't necessarily match that kind of new narrative around more nationally protective politics. So I think that that will be interesting to see who comes out," he adds.

Crighton also highlights a potential development management opportunity surrounding the government's ambition to increase its defence real estate, especially if it heavily involves the privates sector.

"Most of the big defence contractors and manufacturers are broadly present in the UK, the likes of BAE Systems, Raytheon and Thales, which are the core backbone in the UK. Would they speculatively invest in scaling up? Like any other sector, there will be an element of readiness within the business.

"But would you commit to it without a firm contract? Potentially no. I would imagine there will be some kind of positioning and readiness ahead of tenders and securing contracts. People will want to put [their foot] down on the pedal quickly to produce."

Despite increased government spending on defence, he says defence-related manufacturing will continue to make up a small amount of the overall activity in the UK warehousing sector, with third-party logistics and ecommerce keeping their stronghold.

"Whilst we're talking about the growth of this sector, it's something which is going to remain important but a minority component in the sector. [That] would be my guess unless we see a very material commitment from the government on spending."

Speaking the morning before the Chancellor's Spending Review speech, Charlie Withers, development director and partner at Tritax Big Box REIT, says the impact of increased defence spending is unlikely to be felt in the warehousing sector for at least six months.

He says this is because it will take property companies a minimum of half a year to get their business plans together and to work out what they want to do. But Withers says increased defence spending is a potential tailwind for industrial logistics, highlighting that warehouses will be needed to store military paraphernalia.

"Certain elements of this push on defence will result in higher levels of inventory being stored by the Ministry of Defence; equipment, kit... that will be positive for the logistics warehousing sector.

"Over the last 20 years you would expect that inventory has been kept at a fairly low level, but one would anticipate that this will increase over the next few years as defence spending increases, so you have that element that I think will impact B8 logistics."

Tritax Group's head of occupational leasing, Mark Fergusson, says he does not expect to see take-up from the defence sector, including manufacturing, to be "going backwards" anytime soon, highlighting that it has made up at least a fifth of industrial warehousing take-up in recent years.

"That wider industrial strategy around clean energy, life sciences, manufacturing and defence, you’ve got to think that will be maintained along those sort of lines for the foreseeable future and take a bit more market share," Fergusson says."

While it may be too early to measure the real effects of the government's plans to increase defence spending, Withers says Tritax Big Box has also seen early requirements come to the market.

"It is across all sizes really," Withers says, "from the smaller-end, [around] 100,000-square-foot-type buildings for storage of supplies, to 120 acres for specialised manufacturing. But there is nothing out there at the moment to the best of my knowledge that anyone has landed."

Withers explains that the defence sector prefers to own its facilities, meaning there will be less clamour for existing properties available on the market. But he says companies with large land holdings are likely to benefit from built-to-suit warehouse projects.

These types of facilities, Withers and Fergusson say, are likely to be built in or around existing facilities, whether that is the strong aerospace presence in Bristol or marine defence specialities in the North East and Scotland.

"We have a very large nationwide land portfolio, and we are in discussions in a couple of locations with defence-related parties," Withers says.

"I think we will land some of those where there is more high-tech… if it’s more heavy manufacturing they will end up in those types of locations which you would expect."

He adds: "Because of the bespoke nature of the buildings and their long-term nature of investment, a lot of the manufacturers would prefer to own and buy which, in certain locations, we are happy to accommodate and look at.

"But, if it is really specialist, it makes it difficult to be an investable proposition for a REIT or a long-term investor because the buildings aren’t tradable if they come out."

Withers adds that it will be interesting to see what happens over the next six to nine months in regard to defence-related activity in industrial warehouses.

"I think it is going to take time for the relevant players in the defence industry to take on board the direction of travel that the UK plc is going in relation of defence.

"Six or eight or 10 weeks after the announcement is way too early [to tell], but it will be interesting to have this conversion in March next year to see what has happened then.

"We are well placed to take advantage of the uptick in that sector, we’d already seen that there had been an increase in manufacturing demand over the last two to three years."

Defence spending is also ramping up in mainland Europe, with Germany pledging to 3.5% of gross domestic product on defence by 2029 through a circa €400 billion borrowing programme, with NATO leaders then agreeing to increase spending to 5% by 2035.

Asked how pledges from governments to increase defence spending across Europe has impacted the warehousing market, Bert Hesselink, group client relationship director at European warehouse owner CTP, says "That is a fantastic question and I would love to have a very precise answer."

But he has noticed a recent increase in demand for warehouse space from defence-related industries, who are looking to "rent space, and rent space quickly".

"Why do they want to rent it quickly? It’s so they have a competitive edge to win new contracts that are related to this increased spending on defence that national governments are now getting ready for," he adds.

"We are already seeing signs right now that companies are deciding to lease space that we currently have under construction or is immediately available and will to pay a slight premium for that for the reason [that they are] ready to win these contracts.

"We have examples in our portfolio where this has already happened and we expect quite some significant growth in this area."

Hesselink expects a "significant level of increase" in the amount of warehouse accommodation defence-related companies will take up over the next year, but argues this won't impact the wider industrial and logistics take-up market too dramatically.

"We are still renting out the majority of our space to third-party logistics providers, manufacturing companies and, yes, defence is a part of that. But I do expect the share of defence-related industries to increase," he says.

He also highlights that increased demand for warehouse accommodation from defence-related firms could be a bonus for the sector when interest and activity from other industries has waned.

"The growth in defence is compensating for some dips in some other industries because, if you look at real estate market data and space under construction and the amount that is leased, it is slowing down and the increase in defence-related demand is softening the slowdown."

Hesselink says defence-related growth of the warehousing sector is most likely to occur across Central and Eastern Europe, including countries such as Germany, Hungary and Romania, with activity again excepted to be focused around existing clusters.

He argues that the initial interested from defence-related firms will be for manufacturing accommodation, which will then lead to requirements for logistics and storage accommodation. He describes this as a common "trickling-down" effect seen across other industries using sheds.

Hesselink adds that speculative warehouse developers will likely to be the main beneficiaries of moves by defence-related companies to take space across Europe at the early stages, supporting the idea that activity could work with ESG goals if viewed as being for social defence.

"In our business model, most of the space that we are leasing and most of the new space that we are constructing is leased to existing tenants, around 75-80%.

Because of that, in order to maintain this high percentage of space leasing to existing tenants, we do everything we can to capture this growth in demand for space from our existing clients. That is why we are always building a lot of space on a speculative basis.

"These spaces that are close to completion or completed, they are of extremely high interest to defence companies because they can move quickly and move faster than their competitors to bring in these contracts. We are able to achieve higher than expected rents when renting the spaces to these defence-related companies."