Retail Headwinds are Tailwinds for Industrial and Driving Historic Growth
The robust retail supply chain readjustment is cascading through the entire economy and industrial real estate may be the biggest beneficiary.
Recently we’ve focused on the growing pain in the retail sector as a result of record store closures as well as the transformative growing pains being experienced by a retail industry that might also open a record number of new stores this year. The same forces driving mass disruption in the retail space are sweeping structural change through the entire supply chain. And it’s the very same headwinds downing so many former retail high flyers that are simultaneously acting as tailwinds boosting industrial growth to new heights.
It turns out that industrial may be the biggest beneficiary of the mass evolution in the retail supply chain. CBRE estimates that for every $1 billion increase in sales for e-commerce there is 1.25 million square feet of absorption of logistics space.
So with the e-commerce sea-change reaching critical mass, it’s no surprise industrial vacancy is at an all-time low. Nationwide industrial vacancy declined again to an aggregate 5.6% in the fourth quarter of 2016 (compared to 2015), according to the year-end industrial market report by JLL. Rental rates for industrial space have hit record highs, breaking the $5 per sq. ft. triple-net barrier for the first time ever, according to the same JLL report. This has set off a building boom as large investors respond by leaning into industrial property with unusually intense interest. The biggest challenge for industrial investors right now may be finding assets to buy.
Sales of industrial properties grew by 3% in the first quarter compared to 2016, according to Real Capital Analytics, far outpacing GDP growth. Retail sales growth has been running even hotter—4.5% this April compared to April ‘16—but it hasn't spared most non-prime or below 'A' class retail properties from suffering. By contrast, the industrial property segment is outpacing all of its other commercial property counterparts, where sales are flat or slowing down. Real Capital Analytics reports that investment sales involving single industrial assets reached a record deal volume in the first quarter—a 15% increase over the first quarter of 2016.
All new deliveries last year totaled 224.5 million sq. ft. nationwide—besting the previous record high of 199.2 million sq. ft. in 2008. And there is no sign of slowing down in 2017. First quarter groundbreakings were up 24% since the fourth quarter of 2016, according to Cushman & Wakefield’s first quarter industrial market report. E-commerce fulfillment drove the absorption of 53.8 million sq.ft. of warehouse and distribution space in the first quarter. That’s down 14.4% from the first quarter of 2016, but still well above the quarterly absorption average of 49.3 million sq. ft. experienced since the industrial real estate recovery began in 2010. The first quarter of 2017 “marks 28 quarters of net occupancy gains, placing the current expansion among the longest on record,” the report stated.
The limited land availability and increasing rents are not slowing demand for industrial space. Retailers and third-party logistics providers are demanding more distribution space “with the majority of deliveries coming online in major industrial markets and primary inland distribution hubs” served by rail and truck transportation. Especially low vacancy rates were recorded in seaport cities, including Los Angeles, 1.3%; Seattle, 3.4%; Oakland/East Bay, 2.3%; and central New Jersey, 4.1%.
Speculative building is up. “[B]ut the majority of speculative development remains concentrated in primary industrial markets, as does the most significant notable leasing volume,” said Jason Tolliver, Head of Cushman Wakefield Industrial Research, Americas. “The Inland Empire, Dallas and Atlanta are where one-third of the nation’s speculative projects are underway, but these markets also turned in the strongest first-quarter leasing performance, comprising nearly 30% of all U.S. net absorption. The script has been the larger the market, the stronger the leasing, and the greater the development. Both eCommerce and international trade are driving logistics-related development, and the growth of both is accelerating.” Tolliver added.
According to Cushman & Wakefield:
With online sales still only making up a small fraction of total sales, as we covered previously, we’re still in the early stages of this evolutionary phase of growth.
Changing consumer preferences and behavior coupled with new technologies are changing the game. The new huge and highly automated fulfillment centers—like the $1.4 billion air hub Amazon is planning to build near the Cincinnati/Northern Kentucky airport—are needed to meet the ever-growing demand to process and ship goods to consumers spending records amounts online. Wal-Mart is catching up to Amazon in the logistics race and other big retailers like Nordstrom are working hard to meet or beat Amazon as well. Nordstrom recently announced the construction of their third large fulfillment center, a 672,000 sq.ft. center in Elizabeth, PA.
Of course not everyone can play that game and win, which is why there is growing demand for third party logistics (or 3PL). Very few players will need their own close-in industrial space. Everyone else will need to use 3PL in order to stay in the game. So, as practically every retailer migrates to new modes of delivery, it creates large demand for the high ceiling, transportation accessible logistic support facilities 3PLs utilize. And now that it’s easier and cheaper than ever to ship to anywhere in the world, small firms and individuals can find a niche and become successful micro-retailers by setting up virtual shop with a global supply chain overnight. With the advent of 3D printing and shared production, we are potentially setting up for a return of cottage industry on a scale the likes of which we’ve never seen.
The change in real estate is coming at both ends of the spectrum, too. The same sweeping evolution driving demand for massive facilities is also driving demand for smaller facilities located near or in populous urban centers. These “last mile” fulfillment centers are essentially the last stop in the supply chain before an item is finally delivered to your front door or building’s package room. These types of facilities can operate in smaller footprints and absorb the higher cost of urban land because of the ultra-high value they can produce by delivering convenience. Now in mere hours or minutes and soon by drone.
And it’s not just logistics. The industrial space is heating up across the board. Cheap U.S. energy and wages that have held flat for so long that wages around much of the rest of the world have caught up (making U.S. labor more competitive) are both helping to reshuffle the global industrial order. These structural evolutions put the U.S. in a very advantageous economic position once again. U.S. industrial production in April surged with the largest gain in three years heading back towards record levels hit in 2014.
Left for dead for decades, U.S. industrial is back in a big, big way. It’s evolving into new, stronger forms. And its best days seem yet to come.