Strong market fundamentals point toward continued growth in 2020.
At most gatherings of industry professionals in the multifamily and commercial real estate space, and, at some point, you’ll hear a variant of this question: In which property type are you placing bets, given where we are in the cycle? Aside from multifamily, the next most-often mentioned property type is industrial. “What is depressing retail fundamentals is helping boost demand for industrial,” said one panelist at the Mortgage Bankers Association Commercial Real Estate Finance Convention and Expo held this past February.
This observation is, to a large extent, true. Unlike the retail (or even the office) sector, where vacancies have barely fallen by 100 basis points over the last seven to nine years following the last recession, industrial vacancies have fallen by anywhere from 400 to 600 basis points. Asking and effective rent growths at the national level have also risen at a healthy clip, between 3 to 4 percent per annum over the recovery period from 2012 to 2017. If you limit coverage to Class A industrial space, you’re looking at national effective rent growth between 5 to 6 percent per year over the same time period. These figures are two to three times the growth rates experienced by office or retail, rivaled only by multifamily in 2015, its peak year of rent growth.
Significant improvements in market fundamentals over a sustained period, of course, is a signal for developers to bring product to market. Consider the warehouse/distribution subsector, which is often the subject of optimistic discussions regarding urban infill locations for last-mile operations by retailers like Amazon. The national vacancy rate fell from 14 percent in 2010, right when the recession ended, to a low of 9 percent in 2017. That same year, construction figures broke 100 million square feet — as it has consistently done every year through 2019.
As a result, vacancy declines vanished, and asking and effective rent growth fell from highs of 3.7 percent and 4.4 percent, respectively, in 2017, to below 3 percent for both 2018 and 2019. Vacancies began to tick upwards to 9.4 percent in 2018 and ended 2019 at 9.9 percent. Additions to inventory outpaced net absorption, and no respite is in sight for 2020 as another 100 million square feet are slated to come online this year.
The Sky Is Not Falling
Still, a moderation in fundamentals amidst strong supply growth need not signal a major cause for concern. “All remains solid despite new supply outpacing absorption in 2019,” writes CCIM Institute Chief Economist K.C. Conway in a recent note. “A lot of this new supply is pre-leased under non-disclosure agreements so [it’s] treated as spec.” Economic demand as measured through port activity, shipment volumes, and other performance statistics all appear to have shrugged off worries of trade wars or recessions in the near term.
One measure of the health of the industrial market is an examination of how some of the largest players are positioning their portfolios. Blackstone, for example, is actively managing its portfolio, which includes 180 industrial properties across some three-dozen markets; it was involved in one of the largest purchases of industrial buildings in 2019, valued at $18.7 billion, from Singapore-based GLP in September. Blackstone then promptly turned around and sold about $3 billion in properties to Nuveen Real Estate the following month. In December, Blackstone bought Colony Industrial’s portfolio of close to 500 last-mile infill industrial assets for $5.7 billion.
Prologis has been similarly active, closing deals to acquire $4 billion of industrial properties from Industrial Property Trust in January, and Liberty Property Trust’s portfolio of over 110 million sf of logistics space for $12.6 billion in February. While valuations suggest that it is a good time for many players to sell, the biggest market participants appear to be the ones buying, doubling down on industrial’s relatively strong future.
Exuberance and Caution from Capital Sources
One theme that emerged from the January meetings of the CRE Finance Council in Miami was that a lot of capital is waiting and eager to be deployed toward investment in income-producing assets. Preliminary estimates from the Mortgage Bankers Association suggest that issuances across all lender types came in at $628 billion in 2019, up over 9 percent from 2018’s $574 billion — which was already a record year. That number could rise by another 9 percent this year to $685 billion. Industrial is likely at or near the top of the list for most capital sources given property fundamentals and the near-term outlook.
Still, several lenders at a panel moderated by yours truly at the Mortgage Bankers Association titled “Bank Lending Trends in the Long Cycle” suggested some caution. “Most players are looking to industrial for some deals since the playing field feels like it’s getting crowded,” one banker noted. “Non-traditional lenders that aren’t constrained by regulators in the same way as banks are more willing to take risks on construction loans, and that’s the kind of game you might not want to win, let alone join, from a pure risk management perspective.”
Industrial fundamentals appear solid despite several years of strong supply growth. But just because the tide continues to lift most markets, analysts and underwriters can’t forgo deep market-specific analysis when making investment, lending, or development decisions about specific deals. In late January, the International Monetary Fund revised its 2020 global GDP growth projections to 3.3 percent, up from 2.9 percent in 2019 (the weakest performance in about a decade). Even if the U.S.’s GDP growth projections were lowered to 2 percent for 2020, more optimistic projections for major trading partners like Mexico offer continuing support for a sanguine view toward industrial. Uncertainties exist like the 2020 presidential election, but unless a significant unexpected event knocks global GDP growth off kilter, industrial is likely to do well this year.
Resource: “All Is (Mostly) Well in Industrial with Reis“