Should we start with the good news or the, well, not so good? On the good news side, the industrial market is pretty much where we left it in SIOR Report’s Q2 market update. Namely, the national market is so tight that B product is still gaining allure for prospective tenants, even those who a few years ago would have considered only A product for their needs.
Further, “CBRE researchers anticipate that another 300 million square feet of industrial space will be absorbed on the back of e-commerce alone,” the article continues. “However, due to the need to research and develop, produce, and store COVID-19 vaccines, the explosive growth of life sciences and cold storage have also thrived in the pandemic and are expected to continue.”
Clearly, industrial is a market enjoying robust interest from tenants and investors alike, a far cry from the current situation that exists in the office sector. “Overall U.S. office absorption remained firmly in the red in Q2 2021,” reports Colliers, placing it at negative 18.6 million square feet. The report does give a nod, although slight, to a little good news, stating that at least this is “markedly lower than the negative 46.1 million square feet seen in Q1 2021, which was the worst quarterly total on record.”
Let’s get back to the good news. “The industrial market remains strong as e-commerce continues to gain more and more share of the sales that would normally go to retail brick-and-mortar stores,” agrees Sim Doughtie, SIOR, president of King Industrial Realty, Inc./CORFAC International in Atlanta.
Of course, this is not to say the industrial market is without its own woes, as major, months-long disruptions in the supply chain—also noted in Q2—continue to plague the industry, both in terms of on-time deliveries to e-commerce clients as well as the building delays and price hikes caused by hang-ups in the delivery of construction goods. “If you ordered steel to build an industrial building on Oct. 1, you won’t get the steel to the site until July of 2022,” says Doughtie.
One possible solution, in motion as we speak, is more onshoring and nearshoring with a greater reliance on backyard countries such as Mexico. “China has had significant labor increases over the past 10 to 15 years,” says Dallas-based Conrad Madsen, SIOR. “When you factor in the logistics costs, port delays, and challenges with China, Mexico is now on the same playing field for manufacturers.”
In fact, Madsen, who is cofounder of Paladin Partners, has personally handled, “dozens of deals” on the other side of the Rio Grande river over the course of his career. “Final product can be in your distribution center in Dallas/Fort Worth or San Antonio within a day’s truck drive from any of those border towns, and in your customers’ hands in literally days as opposed to four to six months from the east.”
That assumes, of course, that labor shortages and rising fuel costs don’t continue to plague the trucking industry. Madsen adds parenthetically that other offshore nations such as Thailand and Vietnam, nations with whom we have smoother relations than with China, could also share in global shifts in supply chain sourcing.
In the meantime, delivery issues can be seen as a boon, at least for brokers, if not for tenants. “In the past 10 to 20 years, most manufacturers relied on just-in-time inventory,” he says. “Now the trend is more toward just-in-case inventory strategies, meaning that they need extra space for additional storage. Most are seeking 10-15% extra inventory to prevent future supply chain interruptions.”
Which, of course, cranks up the demand still further for those landlords. “It’s great news for the industrial sector,” he says.
THE HEADLINES FOR 2022
“Sheds and Beds,” says Madsen frankly. “That’s the headline for next year.” He explains that industrial and residential (including single and multifamily) are the “two most attractive asset classes in commercial real estate for institutional and private capital, far out-distancing office and retail,” both of which are “currently on the backburner. We’re pre-leasing a speculative distribution center just north of the (DFW) airport. We broke ground three weeks ago, and we have countless proposals on the table right now.” He says the owner won’t even consider tire-kickers or anyone looking for less than a 10-year term, “That’s how robust the market is for well-located industrial.”
Office might be taking a temporary pause in Dallas. But the ups and downs of commercial real estate’s fortunes shift from market to market. Unequivocally, for brokers such as Ted Konigsberg, SIOR, president of Infinity Commercial Real Estate in Miami, the 2022 headline will be “Commercial Markets on Fire.”
An influx of corporate tenants is driving what Konigsberg calls “a shift in population and capital flows. In effect, the northeastern markets and—believe it or not—the far west markets, like California, have descended upon us. The investment community perceived our purchase prices, lease rates, and lifestyle as significantly better than what they were experiencing.” The adoption of technology enabling remote work during the pandemic has only accelerated the trend.
CBRE research seems to agree, reporting that in Q2, some 1.1 million square feet of “new-to-market” tenants have indeed stormed the so-called Magic City. In downtown Miami alone, investors splurged to the year-to-date tune of $763 million, with “another $203 million in Airport/Doral and Aventura for a grand total of $966 million, exceeding total investment sales in pre-pandemic 2019 at the mid-year point.”
But don’t go by the headline alone, not without reading down the column. Konigsberg adds that the office market is subject to nuances that are less than stellar. He sees the suburban markets as stronger currently, owing in part to a rise in hub-and-spoke leasing strategies and more remote and hybrid work policies. And older vertical buildings in the central busines district can’t hold a candle to newer construction coming out of the ground. (CBRE reports more than one million square feet has been developed year-to-date in the suburbs.)
In fact, Konigsberg is pushing more into secondary markets due to the tightness of space in Miami, especially due to a lack of developable land. “An enormous percentage of our business now is in secondary Florida markets around the state with good infrastructure and amenities.” He does add, happily, that through his SIOR network, his firm is making further inroads nationally.
CAUTION IS STILL A MARKET FUNDAMENTAL
However, even markets riding a counter-cyclical wave of leasing and investment activity cannot escape the ongoing impact of COVID-19, now in the form of its Delta variant. And while the industrial market by all counts seems to be on an ongoing growth trajectory, “caution” is still the word of the day.
“Caution’ is still the word of the day.”
So, not surprisingly, on one hand, Konigsberg says he’s optimistic about the long-term outlook, yet he admits to being “conflicted in the short term.” And the major cause is the ongoing health issues as COVID-19 rolls into more variant strains.
But he’s also concerned about potential changes to interest and cap rates, as well as the cost of funds. “You can buy something at a four cap and still make money,” he says. “But what happens when the Fed starts tightening up the bond market? Between the funding market and our national health situation, there’s too much that’s out of our control to be completely optimistic about the short term.”
Doughtie piles on with other concerns of a political nature: “The outlook really depends on our government and if their policies will help or hurt the markets.” On one hand, he supports the $1 trillion infrastructure bill that’s currently being kicked around inside the Beltway. “It’s something the country needs, as long as the dollars actually go to infrastructure.”
But the $3.5 trillion “Reconciliation Bill,” has him a bit nervous. “It would increase taxes on everyone,” he says, “and that would cause our economy to slow down.”
On a scale of one to 10, he puts his overall optimism quotient at eight. It’s an optimism based more on the private sector than on politicians. “It takes into consideration that the government will continue to make mistakes, and the free market and smart businesspeople will find a way to make it all work.”
Madsen too is conflicted, but his focus is closer to home—on the fundamentals of industrial and office asset classes. Not surprisingly, “in terms of industrial in Dallas/Fort Worth, and on a scale of one to 10, I’m at 11,” he says. “DFW is the most diverse and prosperous economy on the globe today. We’re the catcher’s mitt for the majority of the large corporate relocations, the epicenter for logistics in North America and we see almost 400 people a day relocate here. I would not want to do business anywhere else in the world right now.”
Also not surprisingly, the office outlook for 2022 raises a bit more caution. “Too many firms, especially the Fortune 500, are still trying to figure out how to move forward. They’re scared to make a decision due to liability concerns, which is odd because all of the Fortune 500 paused only briefly on industrial-sector operations because they had to crank up the assembly lines and distribution centers to get their product to the customer. Ultimately, they cannot continue to kick the can down the street concerning their office footprint operations.”
And as long as uncertainty overhangs the office market while the light continues to shine on industrial, “that will be the headline for 2022.”