Industrial CRE’s “strong fundamentals” mean resilience

A recent report – released in late May 2022 – shows the industrial commercial real estate (CRE) boom is far from over, even when the “headwinds” are accounted for.

The May 2022 Matrix Industrial Report, from Yardi Matrix, says that although the “economy hit a rough patch in the first quarter due to inflationary pressures and rising energy prices, […] demand for industrial space continues to be robust”.

The continued presence of market fundamentals like increased consumer spending and job growth are adding to the sense of resilience seen from the sector, which has made huge strides since the dawn of Covid-19 kicked online shopping and fulfilment into particularly high gear.  

Drag factors

CRE in general and the industrial CRE sector in particular do face a range of economic pressures as we look to the second half of the year. Slower economic growth in the first quarter, supply chain issues, and “persistent inflationary pressures” are not insignificant depressive factors, but the drivers of demand are not going anywhere either.

Boost factors

The boost factors, on the other hand, include “healthy consumer spending”, and “the need to bring the nation’s stock up to snuff to support modern logistics”.

Additionally, occupancy across most US metros remains high and “rents are growing well above historical levels around the country,” according to the report. Rental averages across the US have increased by 440 basis points year-on-year.

Industrial building supply chain

The report calls the new supply chain for industrial building “extraordinarily robust”, but, as Commercial Property Executive reporting on the report highlights, “[a]lthough the under-construction pipeline is ballooning, experts see the industrial market as severely undersupplied”.

This assessment, from Prologis, draws from several different data sources including the Purchasing Managers Index, retail sales data, and job growth statistics, to posit that the US has “16 months of available industrial inventory”.

Reportedly, over 640 million square feet of industrial space was under construction nationwide at the end of April. Including planned projects takes the pipeline to 650 million square feet.

Global trend

Far from being a US-only trend, demand for industrial is high among most developed economies – or almost anywhere with a strong consumer base demanding more and quicker online shopping and delivery.

As this Financial Times article shows, that’s the case even where Amazon space acquisition is slowing: “There has been record demand for UK warehouses in the past two years,” they write, “with take-up north of 50 [million] square feet compared with a pre-pandemic average of 32 [million square feet]”.

Social: Are you operating in a well-supplied industrial CRE market, or are people scrambling to find space? Tell us where in the world you are, and what the “pulse of industrial” is in your region?

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Record rents point to UK CRE recovery

Reporting in the Evening Standard, based on data from Remit Consulting, indicates improvements in the UK’s commercial property sector. The firm’s data shows that rent collection in the last quarter reached its highest level in the pandemic period, which is partially due to the easing of lockdown regulations in the country.

Data from their REMark Report shows that “…an average of 72.1% of rents due in the UK had been collected with seven days of the September quarter rent day, which covers payments for the three months ahead”. This includes rent for retail and dining establishments, bars, and warehouses. Comparatively, in the previous quarter, 66.5% of rentals due were collected by the same point. Retail rents were sitting at 68.8% (up from 62.3%) and leisure at 57.2% (up from 40.1%).

Good news…

This is in keeping with a general upward trend, the firm told the newspaper, “which is good news for investors and landlords such as pension funds and other institutions, particularly as the upward trajectory of payments from tenants is similar to the previous quarters of the pandemic.”

…but not all good

Despite the strength of this news, it’s not a unilaterally positive picture, as the data also indicates that this ‘record high’ is still considerably lower than pre-Covid levels. Altogether, since the start of the pandemic, there is a shortfall in rent from commercial occupiers amounting to nearly £7 billion – a considerable chunk for property owners and investors, including institutional investors such as pension funds.

Managing the fallout

The matter of the “missing rents” is something the industry and public service are keeping a close eye on. This report from the International law firm Morrison & Foerster LLP gives an excellent rundown of the public consultation that the UK government has done around trying to establish a way forward for both struggling commercial tenants and landlords.

The policy paper published in August 2021 can be found here, and outlines the government intentions to “legislate to ringfence rent debt accrued during the pandemic by businesses affected by enforced closures” and their intent to formalize a “process of binding arbitration to be undertaken between landlords and tenants”.

Meanwhile, a number of the large and influential property industry associations have called on the government to end the moratorium on evictions that came into effect during the height of the pandemic and lockdown measures.

CRE outlook stronger despite supply chain challenges

Since April 2020, the National Association of Industrial and Office Properties (NAIOP) has been keeping track of the pandemic’s impact on CRE with their regular COVID Impact surveys. NAIOP’s June 2021 survey collected data from 239 US-based members, including brokers, building managers and owners, and real estate developers. A recurring theme in this latest survey was the increasing challenges commercial real estate (CRE) is navigating associated with supply chain disruptions and materials costs.

Supply and delay
With more than 86% of developers reporting delays or materials shortages, it seems the impact of COVID on supply chains is set to become one of the longest-lasting effects of the pandemic. Adding to difficulties, 66% of those surveyed reported delays in permitting and entitlements, a figure that hasn’t changed since June 2020.

Fixtures and equipment for stores are also in short supply, with order backlogs stretching into months for some retail sectors. While this isn’t necessarily surprising, given setbacks in manufacturing in key suppliers such as China, the CRE market shows promising signs of being on-track for continued recovery nonetheless.

Development despite setbacks
Despite the issues highlighted in the report, the survey still showed an increase in retail prospects. New acquisition of existing retail buildings was indicated by 39.1% of respondents, while 31.3% mentioned new development going ahead. Both of these figures represent a strong improvement from a previous survey in January. Deal activity was also noted to be on the up, with figures doubling for office and retail properties over the course of a year, and industrial deal activity increasing over 20% since June 2020.

“Bricks and clicks”
International industry players have also noted that, though larger spaces are still facing delayed rental uptake, 20,000-30,000 square-foot sites are garnering increasing interest. The potential for these spaces is as part of a multichannel retail/warehouse approach – the “bricks and clicks” strategy. As the demand for online retail increases, logistic assets, and storage spaces become more valuable, contributing to an overall uptick in both virtual and brick-and-mortar marketplaces. 

A promising prognosis
Even with the supply chain challenges facing the industry, the Federal Reserve agrees with the trend data gathered from NAIOP participants. In their June 2021 Beige Book, the Fed noted upward movement in industrial output and consumer demand. Though economic gains were noted to be slow, the outlook remains steady and positive.

President and CEO of NAIOP, Thomas J. Bisacquino, puts it like this: “The materials and supply chain issues are lagging effects of the pandemic, and they are affecting every industry. While the pandemic’s impact was deep, there’s a sense of optimism among NAIOP members, with deal activity rising and an increase in people returning to offices, restaurants and retailers.”

Industrial CRE: the party isn’t over yet!

Real Capital Analytics (RCA) has released their latest US National All-Property Index data for industrial, apartment, retail, and office sectors, which shows index growth of 8.4% year-on-year to April 2021.

The biggest gains were evident in Industrial (up by 9.4%), which we all know has been one of the few spaces for which Covid-19 proved to be a boon. But GlobeSt analysis of Crexi data and Moody’s Analytics suggests that a “market correction” may be on the cards

In the monthly Crexi National Commercial Real Estate report, they write, ‘for industrial… prices dropped 6.68% over April Figures, forcing cap rates up slightly in response”. However, occupancy rates in Industrial have increased over six months, by some 11.59%, and the asking rate per square foot is not at its highest levels since before the pandemic.

Multifamily prices, by contrast, increased some 10,5% but their occupancy rate declined slightly.

Rent potential

Moody’s data also shows that rent for warehouse/distribution was “positive nationally for every quarter” of 2020, and they anticipate it will also prove to be the “strongest rent of all asset classes this year”, with rental growth of 2.8% predicted.

Demand growth

Areas that are particularly well placed for Industrial and warehousing spaces – or those that have higher demand – will reap the rewards of this ongoing strength.

Florida, for example, reportedly has much need of at-home deliveries. Lawyer Bruce Lowry in a recent article said: “This area has spiked. The vacancy rates are extremely low, if not at zero, for warehouse space.”

He argues that this trend will hold for the immediate future as older consumers have become comfortable with delivery services “rather than having to go into a store”, and that the need for warehouse space to address this is not yet up to demand.

eWarehousing

Other factors to consider is the rise of “subcategories” like eWarehousing, fulfilment, outsourced or third-party logistics. As smaller companies adjust to offer robust online sales and delivery, or through microfulfilment, shared space providers are having to grow and accommodate newcomers.

Those who have run on a “just in time” model, are having to find space for large stockpiles, and the last mile means that industrial is coming into closer proximity to the city centers and suburbs they’ve never featured in before. 

For a rundown of the options, this GlobalTradeMag article offers an accessible guide to the types of industrial sub-categories that are going to be of increasing interest.

Thought leadership: A new lease on life for old retail spaces

In a recent announcement, LightBox principal analyst Dianne Crocker predicted that as many as 25% (a quarter) of America’s malls can be expected to close down within the next three to five years.

This is, obviously, a trend that commercial real estate (CRE) professionals – like us within NAI Global – have been aware of and tracking for many years, but the LightBox prediction goes on to offer some idea of what we can expect to see filling these spaces in future and what investors see as the opportunities created by this trend – both projections worth exploring.

The “death of retail” has been hanging over the industry’s head for the better part of a decade, but what is more likely – Crocker and NAI agree – is a move away from brick and mortar towards e-commerce, with a hybrid model in future. This trend was merely heightened by the Covid-19 pandemic.

The Amazon effect

This is in line with what trend analysts and futurists like Doug Stevens are forecasting. Stevens told RetailDive last year that by “2033 the majority of our daily consumption will be transacted online”.

“In the future, all but the most convenience-based retailers will begin to use their stores as media to acquire customers and their media platforms as stores to transact sales…” – Doug Stevens, author of “The Retail Revival: Re-Imagining Business for the New Age of Consumerism”.

This tracks: Our most recent Real Estate Outlook study, Q42020, found that over half of the survey respondents (57%) said the “Amazon effect” was expected to have an even larger impact on their CRE markets than the pandemic itself.

A buyer’s market

Crocker argues that the slowdown in deal volumes initiated by the pandemic has left a supply gap, and described the demand from investors as “pent up”.

“Institutional capital right now is focusing its repurposing investments on the safest benefits, the suburban metro areas that have seen meaningful growth in the past year…” – Dianne Crocker, LightBox principal analyst.

Multifunctional malls with a lifestyle component are not only the darling of consumers, but of investors too including private equity firms looking to score a bargain on a distressed CRE asset.

We are seeing this interest spiking too, and not just for straight sales. There is much interest in reusing these generously sized spaces in novel ways.

There are many such developments on the cards around the country. In Benton Harbor, Michigan, plans have been suggested to reconfigure the Orchards Mall with some 116 luxury two-bed apartments, with six-month leases to attract business travelers. Chapel Hill Mall in Akron, Ohio – which was foreclosed – expects to see new life as a business park.

There are also some less-traditional buyers in the market for malls these days. Gaming giant Epic Games recently bought up an almost 90-acre defunct mall in Charlotte, NC, that will be refitted into their new international headquarters.

Repurposing and extended life

The malls that outpace the trend will be those with a strong anchor tenant and those that offer the live-work-play balance. Crocker argues that malls that are grocery-anchored, or those “featuring medical services, pharmacies, gyms, and lifestyle amenities are more likely to survive in their current forms.” This is the kind of mall that will become a hub of urban life, she says.

An anchor tenant with a multichannel presence and a pandemic-proof loyalty is a gamechanger for mall and retail leasing.

Malls also have, we believe, a long life ahead of them as places to showcase goods and establish brand experiences. Raydiant makes digital experience tools for real life spaces. Writing for Forbes in 2020, Raydiant CEO Bobby Marhamat wrote that “in-store experience defines retail for people”.

“Touching products is part of that experience, but helpful staff, well-organized showrooms, unexpected activities, smart technologies and other components all combine to create exceptional experiences…” – Bobby Marhamat, Raydiant.

These factors combined are why smart money is betting on not ‘a death’, but ‘an evolution’ for our malls.