As a current owner of industrial properties in St. Louis—and looking to add to that portfolio—being conflicted about market fundamentals isn’t necessarily a bad thing; it’s challenging, but not necessarily bad.
Activity is strong, cap rates are compressing and values are increasing. That’s good news for the five buildings totaling more than 1.5 million square feet of space that we at SparrowHawk and our partners own throughout the St. Louis market. Yet as we look to further expand our holdings there, we must also accept that the competition for listings and asking prices is also increasing.
We remain bullish on the St. Louis market, given the leasing and activity trends we’re seeing as well as St. Louis’ favorable economic and geographic position. Following is a recap of some of the most positive characteristics of the marketplace, along with certain things that create concerns that can’t be overlooked.
Throughout the pandemic, St. Louis has continued to see a strong level of demand and completed leases among the large national users engaged in ecommerce businesses feeling the direct impact of the virus. This wasn’t surprising as consumers turned to ecommerce and related business to fulfill purchases of everything from soft goods to groceries to household necessities.
The big difference in the last 45 days or less has been the increased level of activity by smaller users—those ranging in size from 25,000 square feet to 50,000 square feet and 100,000 square feet to 150,000 square feet. This is an indication of the strength of local and regional firms and a market characteristic that is welcomed by everyone. That strength is further underscored by the fact businesses are leasing space that will satisfy current requirements and give them space for future growth. That bodes well for the local economy and industrial property owners/investors.
There are explanations for this growth:
- Ecommerce – Before COVID, it is estimated that approximately 15 percent of retail sales were attributable to ecommerce. At the pandemic’s peak it moved to 25 percent to 30 percent and has now settled in at 20 percent or more, which is well ahead of growth projections. To accommodate that growth, companies need more space for product.
- Supply chain disruption – In St. Louis and across the country, companies experienced supply chain disruption either because of product coming from China or other international locations or because suppliers’ manufacturing operations were shut down because of COVID. In response to that, many companies are getting away from a just-in-time approach to a just-in-case strategy where they will “stockpile” inventory.
Interestingly, if these companies expand to accommodate the 5 percent growth, industrial vacancy in St. Louis could be eliminated.
As impactful as the COVID pandemic has been on industrial real estate because of all the essential services it supports, it is also creates concerns and challenges. COVID has put a tremendous strain on state and local budgets and revenue streams. One of the easiest ways to recoup those lost revenues and make up for deficits is to raise real estate property taxes. Local officials are much more likely to raise taxes on commercial rather than residential properties because commercial properties don’t directly impact as many voters!
The trickledown effect is that an increase in property taxes, which is passed along to tenants, makes it significantly more challenging to increase rents, which in the long run will impact cap rates and values.
In spite of that area of concern, one of the real challenges today, in primary, strong secondary and emerging markets, is the competition for acquisitions. Institutional and high-net-worth investors are increasing their allocations in real estate, either to take advantage of strong performance or to balance allocations. This competition we’re seeing in St. Louis, especially for strong performing assets, further compresses cap rates and makes product more expensive to acquire.
That means that St. Louis, like a number of other cities in the Midwest, are well-positioned for profitable industrial investments. And it means that while investors like SparrowHawk may experience greater challenges, we simply must work a little harder to weed out the best deals and act quickly to secure them.
Alfredo Gutierrez is the president and founder of SparrowHawk Real Estate Strategists, a merchant investor in industrial properties across the country. He is based in Houston Texas.