Tenant, Investor Demand for Industrial Property Expected to Remain Strong

Plentiful Capital, Growing Direct-to-Consumer Trading, Rent Growth Keeping Sector an Investor Favorite

By Mark Heschmeyer

The outlook for industrial real estate couldn’t be better, despite uncertainty regarding potential changes in

federal trade policies and the large amount of new warehouse/distribution space currently under construction. Recent outlooks cite several sources for continued demand in the warehouse/distribution sector, including healthy-enough consumer spending, growing demand for ecommerce space, and dare we mention it, demand from the growing medical cannabis industry.

Strong Rental Growth Continuing in Annual Logistics Rent Index

Rent growth for warehouse/distribution properties in the US again ranked the highest in the world amid historically low vacancies, according to Prologis Inc. (NYSE: PLD). The US led market rent growth in 2016, rising 5% or more in some markets, compared to an average 4% increase globally, according to Prologis’ annual rental index. Major coastal markets near large population centers outperformed all other US markets by more than 150 basis points, Prologis noted. Rent growth for the warehouse sector is poised to continue, the REIT added. Market vacancies remain at or near historic low levels in most markets and demand is healthy. Development activity, while high, remains disciplined, according to Prologis. Particularly in the US, where it projects a balanced supply/demand picture expected to keep market vacancies low throughout 2017, Prologis said. In addition, the gap between in-place and market rents is at a historic wide level, based on Prologis’ data and estimates, further supporting current market rents. In the US, Prologis reports in-place rents are 15% below market. On average, Prologis customers recently had new lease rates that were 20% to 25% higher than prior rates.

Foreign Investment Targeting US Industrial Real Estate

While office investment remains the top choice for international capital, the industrial sector has seen a significant increase in sales volume in recent years, according to Justin Tochtermann, an industrial analyst for CoStar Group. In 2016, foreign investment in US industrial property totaled $3.2 billion, the highest amount on record next to 2015, which was a monster year for overseas investors, which snapped up a record $18.3 billion in industrial real estate. The record sales volume that year was driven by Southeast Asian capital sourcing several massive portfolio deals. The 2017 outlook for foreign investment in industrial property is strong, Tochtermann added. Notably, the sector was ranked in first place in the Association of Foreign Investors in Real Estate (AFIRE) annual investor survey ranking of preferred property types. CoStar data supports industrial property having the No. 1 ranking, as it remains the best-performing sector overall. According to CoStar figures, rent growth year-over-year in 2016 was 6.7%, more than double the office sector, which posted 3.2% in average annual rent growth. Industrial vacancies continued to decline, dropping to 5.1% as of the fourth quarter of last year, the lowest level over the past two cycles. Responding to the strong demand from both tenants and investors, developers have ramped up construction of new warehouse/distribution facilities with 214 million square feet underway today, 195 million square feet of that is logistics space. Light industrial remains underserved by developers.

Retail Consumption Driving Demand for Industrial

With the emphasis on logistics and getting product more quickly to customers, more retailers are re-purposing fulfillment centers or revamping existing distribution centers to accommodate e-commerce sales. This supply chain reconfiguration plays help to compress the time between when a shopper places an order on their computer and the knock on the door with the delivered goods, according to Kroll Bond Rating Agency. But there is another evolving trend impacting the warehouse segment, KBRA noted: a growing medical-marijuana industry, which is also contributing to the increased demand for warehouse properties in select markets. After Colorado voters approved the use and sale of recreational marijuana in November 2012, industrial rental increases in Denver posted double digit growth in 2013, 2014 and 2015. If the rent growth that Denver experienced is any indication of what could happen in California or other states where recreational marijuana has been legalized, the impact to warehouse space fundamentals could be even greater, KBRA noted. However, KBRA notes that marijuana remains a Schedule I illegal narcotic under federal law, and its prospects for remaining a driver of future demand for warehouse space remains highly uncertain. As a result, the rating agency does not expect to see CMBS loans collateralized by properties with tenants engaged in marijuana-growing activities.

Net Absorption Expected to Keep Pace with 2016’s High Levels

In its first 2017 quarterly forecast, NAIOP is projecting quarterly net absorption of warehouse/industrial space in the US to average approximately 64 million square feet, a level similar to last year. NAIOP’s model is run quarterly by Dr. Hany Guirguis, Manhattan College, and Dr. Joshua Harris, University of Central Florida. Overall, the consumer sector of the economy appears to be boosted by wealth effects from rising stock and home prices, NAIOP said. That topped with employment and wage growth indicates that demand for industrial space in 2017 should continue to favor e-commerce distribution centers. The wildcards for the industry group's forecast include unforeseen changes that could come from revised policy stances on global trade, taxation, hiring, regulation and health care currently up for debate in Washington. Although NAIOP’s model suggests that net absorption could slow to 57 million square feet per quarter in 2018, the group notes the new Trump administration's focus on creating jobs and spurring growth appears to be boosting business and producer confidence.