Elgin Area Chamber Of Commerce: For Industrial Property, The Problem Isn't Demand. It's Supply.

Press release from the Elgin Area Chamber of Commerce:

March 07, 2022

Hamid Moghadam has been at it for more than four decades, and frankly, he’s stunned.

"I've never seen anything like this in 40 years of doing this in our development portfolio," Moghadam, CEO of Prologis, the world’s largest owner and developer of industrial space, told investors on a recent call to discuss earnings. When it comes to leasing new warehouse and distribution space, "people simply can't get the space they need, and it will be several years until supply outpaces demand."

Spurred by the pandemic, analysts say the surge in e-commerce and new ways of approaching supply chains and distribution networks are likely to persist long after the health crisis has passed.

"We do not see any clouds on the horizon," Blaine Heck, a Wells Fargo analyst who tracks office and industrial real estate investment trusts. "There's a significant backlog of demand from tenants."

Yet, while investors are eagerly dropping billions of dollars to strengthen their footholds in the sector, challenges remain. Developers faced with record demand are struggling to assemble the land they need to meet it, and investors are having an increasingly difficult time landing deals for prices that make economic sense.

Rich Thompson, an international director of supply chain anaytics at JLL, said that could mean developers begin building multistory complexes in urban markets where land is particularly constrained and expensive.

"It's a relatively new trend," Thompson said of multistory construction beginning to pop up in the U.S. "We're seeing more and more opportunities emerge as land prices rise and as the need to be closer to consumers become even more critical."

Prologis is creating a blueprint for other industrial developers eager to capitalize on the multistory fad. The REIT is building a five-story distribution center in the Los Angeles area slated to be one of the largest of its kind, and once complete, will span more than 4 million square feet of leased floor area and robot-controlled storage platforms. Amazon is the rumored tenant for the giant warehouse development, which replaces about 70 acres of former dairy land in south Ontario, California.

The retailer has been a lead driver in the push toward multistory development as the company tries to fill in its last-mile distribution network by opening facilities in denser, more expensive cities. In September it opened a 3.4 million-square-foot, five-story facility in San Diego, marking the fourth multilevel fulfillment center Amazon operates in the country, a growing portfolio that already spans more than 15 million square feet.

The pressure to be more efficient with space is especially pronounced in large, coastal markets where the vacancy rates for industrial space have fallen below 1%. JLL's Meyer added that there's "a huge challenge" that will hit sometime later this year for developers who are unable to build buildings in time and keep up with leasing demand. Potential issues such as scarce land availability, rising construction costs or an unforeseen dip in tenant demand could stifle the sector's growth, and developers are moving as quickly as they can in order to stay ahead of any unexpected hurdles.

Even with those concerns, REITs such as Prologis consider it a problem they're grateful to have.

"Every year we've all forecasted the supply exceeding demand, but we have yet to see that happen," Prologis Chief Financial Officer Thomas Olinger said of industrial sector's growth streak.

"It will happen in some year," he said. "I don't know whether it's this coming year or some other year, but I've never seen anything like 70% pre-leasing in our development portfolio. It's a complicated soup, but [declining demand] is not on my worry list."

Shifting Leverage

For now, historic leasing volumes and record drops in available space have given developers and landlords a strong upper hand when it comes to establishing asking rents, which have climbed by more than 8% over the past year.

Increased demand and rising rents have provided the stability and reliability investors crave in an otherwise uncertain real estate market. As a result, the appetite among buyers and developers for the sector is likely to push the industrial market’s strength further into the future.

Related: Warehouse Tenants Face Price Shock as US Industrial Rents Soar

“Industrial REITs are in the early innings of the inventory rebuild cycle due to supply chain constraints,” said Derek Johnston, a senior research analyst for Deutsche Bank. “Demand [for industrial space] remains robust, as the modernization of the supply chain continues to be a key focus for industry bellwether Amazon but is also driving last-mile distribution demand by rivals as omni-channel focused many companies play catch up. At some point, e-commerce adoption will run its course, but we don’t see this as a risk in the near-to-medium term.”

Even once the recent spike in online shopping rates begins to plateau, the pandemic has primed retailers to invest in their distribution networks in order to avoid destructive supply issues or sudden bursts of orders. Those investments are playing an increasing role in retailer's share of the industrial market. The e-commerce sector in years past generated about 35% of the total industrial leasing volume nationally. That figure ballooned in 2021 to surpass 50%.

That appetite has been fed by online sales growth in the U.S. that averaged about 14.5% between 2017 to 2019 and made up about 15% of total retail sales at the end of 2019, according to data from e-commerce researcher Digital Commerce 360. That share of the retail market is now on track to grow as much by as 30% or more within the next few years according to retail analytics firm Digital Commerce 360, meaning the need for more industrial space will only intensify as retailers scramble to build out their distribution networks.

Craig Meyer, president of industrial services at real estate services firm JLL, said manufacturing plants, warehouses and distribution facilities have become the investment “asset class of choice” over the past several years. He added that demand is unlikely to wane as the need for industrial space outweighs what's available.

“Since 2011, industrial rent growth has been positive and vacancy rates have been at historic lows, providing attractive, stable, long-term returns to investors," Meyer said. "These solid fundamentals and the fact that e-commerce still has a long runway for growth makes industrial real estate the darling of the commercial real estate industry.”

Investors have been lured by industrial construction and leasing volume that hit unprecedented heights. More than 310 million square feet of industrial space was completed over the past year, according to CoStar data, while leasing volume surpassed 480 million square feet in the same time. National industrial leasing surged through the first half of 2021 as the nation's largest ports dealt with a severe backlog of shipping containers. Leasing activity has since held above 70% the sector's historical pre-pandemic volume.

Shipping and retail giants used to represent the bulk of industrial leasing volume, but since the pandemic, the shortage of available space has been exacerbated as the spectrum of tenants eager to expand has become increasingly diverse.

Leasing across the country's largest industrial markets is up anywhere between 40% to 80% compared to a year ago, according to CoStar data, mainly due to the widening pool of companies hoping to invest in building out their distribution networks.

Major markets across the country have been unable to meet the demand for space, benefiting smaller, ancillary markets that have picked up spillover leases and construction starts and prompting developers like Prologis to build higher in close-in communities, when they can. The national vacancy rate fell at the fastest clip ever recorded during the third quarter last year, and at the beginning of 2022 stood at a record low of about 4%, according to CoStar data, a dramatic drop from the roughly 9.5% reported a decade ago.

Source: www.CoStar.com

This press release was produced by the Elgin Area Chamber of Commerce. The views expressed here are the author’s own.