Industrial assets are having their moment.
While industrial assets have long been the backbone of the economy, playing a key role in the supply chain from the manufacturing of goods to last-mile distribution, these properties are increasingly becoming a staple of investment portfolios. As e-commerce has become a dominant force in the last 15 years, institutional players are realizing that industrial assets are often investment gold. We sat down with Michael Sleece, Senior Managing Director, REIT Investment Banking, Capital One, for an inside look at the trends shaping this demand.
#1: E-commerce is here to stay
E-commerce has been a big tailwind for industrial demand, and while the hockey stick-like trajectory may be moderating, the sector still has significant growth potential ahead.
“Consumers began to demand quicker delivery of items of all types,” says Sleece. “As such, the need for more locally based storage facilities accelerated.”
E-commerce and m-commerce (mobile shopping) have become entrenched in consumer behavior, including easy “click and buy” opportunities that are increasingly embedded in social media platforms. Younger generations in particular have grown up with digital commerce and are very comfortable buying everything from sneakers to groceries from their laptop or phone.
This behavior has made certain types of industrial assets, particularly bulk warehouse/distribution facilities ranging in size from 250,000 to 1 million-plus square feet and last-mile distribution facilities located within urban centers, incredibly popular, driving up demand and rents.
“The consumer will likely continue to be more demanding, particularly as the younger generation grows into its buying power,” says Sleece. “I expect e-commerce to grow and remain a baseline demand driver for bulk distribution and last-mile logistics facilities.”
#2: Resilience over time
Even with the tide of new supply slowly pushing up the vacancy rate on U.S. industrial in the last quarter, the sector continues to post solid leasing activity, with modestly positive net absorption in that same period.
“While market fundamentals are not as strong as they were from the early 2010s to the early 2020s,” says Sleece, “this is a sector that I expect will continue to prosper given the continued demand for just-in-time inventory and the desire from consumers to have quick and cost-efficient delivery.”
Industrial assets have shown resilience relative to other property sectors for several reasons, such as the e-commerce drivers, acceptance as an asset class in the institutional market and continually rising rents. In addition, the limited number of workers needed to operate these facilities has somewhat insulated the sector from rising labor costs.
#3: Local supply and demand
Real estate opportunities are all about location. For the industrial sector, proximity and ease of access to large population centers are critical ingredients when it comes to facilitating fast, cost-effective delivery of goods. Access to air, rail, ports and/or highway systems are key factors to achieving location success.
Cities with high population growth, such as Dallas, Houston, Phoenix, Las Vegas and Columbus, are where the industrial sector has thrived in the past few years. Port cities, such as Los Angeles/Long Beach on the West Coast, New Jersey/New York on the East Coast and Savannah in the southeast, have historically been key industrial hubs.
Underwriting near-term opportunities
Investors navigating the current market are mindful of both the near-term challenges and opportunities ahead. In addition to location, investors need to be aware of the cost basis when acquiring industrial assets.
For example, some of the higher-end build-to-suit assets were developed at costs that would not make economic sense outside of the original lease that was in place to kick off that particular development. The underwriting of these assets, while using larger double-digit rent increases that had occurred previously, is also not likely to be a sustainable model for the next few years.
“Near-term lease roll will be much more highly evaluated in the near to medium term as the reliance of the incredibly strong market fundamentals that have been in place cannot be solely relied upon for space absorption and out-sized rent growth,” says Sleece. “That being said, Capital One and Capital One Securities will likely continue to be a large source of public equity and debt capital, both on balance sheet and off balance sheet, as we look to grow that aspect of the CRE business.”
Visit the Capital One website to learn more.
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