Real Estate Investment Trusts (REITs) are in high demand in the Midwest. This is true of Chicago especially, partly because of its large population and central location.
We interviewed Mark Crawford, Duke Realty Senior Vice President, Head of Acquisitions; Pen White, Plymouth Industrial REIT President, Chief Investment Officer & Co-Founder; and Adam Moore, First Industrial Realty Trust Senior Regional Director regarding REIT activity in Chicago.
Chicago Industrial Properties: Can you explain what’s going on with REITs in the industrial sector?
Crawford: Fundamentals continue to be remarkably strong for industrial assets. Duke Realty set company records for occupancy and rent growth in 2021. Recently, inflation, rising interest rates and geopolitical risks have caused investors to question valuations. It’s too early to tell if this is a real challenge or a short-term reaction similar to early 2020.
White: Investment continues to increase and looks sustainable for the near future. There’s still a healthy balance between new supply and demand. Demand is absorbing the space on the market, causing rates to increase. That demand is based largely on e-commerce — which is still a strong factor throughout the economy — along with the repurposing of inventory.
More Fortune 1000s are rebuilding inventories or onshoring more product in the U.S., ensuring that they have the product to satisfy customer’s needs. Just-in-time distribution looks more like just-in-case, which is why there’s stockpiling of product across the country. It’s preferrable to waiting to get that product from Asia, Europe, or Mexico and risking supply chain issues.
Moore: The industrial real estate sector as a whole continues to enjoy excellent fundamentals. REITs like us at First Industrial Realty Trust are delivering strong operating results and creating value for shareholders through profitable investments in development of new industrial facilities. Our portfolio of properties located in the top U.S. markets, was 98% occupied at the end of the first quarter, and we are delivering strong rent growth.
Given a national vacancy rate of just 3%, we have expanded our development pipeline to meet tenant demand, with a focus on coastal markets and select submarkets that are supply-constrained. As of April 20th, that pipeline totaled 6.3 million square feet with a projected total investment of $751 million, our largest since we re-launched our development program in 2011.
Chicago Industrial Properties: What’s happening with investment activity, especially as the U.S. continues to recover from COVID-19?
Crawford: Investment demand for logistics properties continues to be strong. Rents continue to grow rapidly making the sector attractive relative to other investment opportunities. There are several new entrants into the sector looking for opportunities and pushing pricing higher, which is great for our existing portfolio but makes acquisitions more financially challenging. COVID-19 restrictions and shelter-in-place orders drove increased e-commerce retail activity and forced companies to reconfigure their supply chains contributing to the industrial sector’s improved performance. As we reach the endemic stage of COVID-19, one of the biggest demand drivers for industrial properties is an increase in the level of safety stock that companies are carrying to offset the volatility in the global supply chains.
White: Activity is still robust. There’s a lot of capital (both domestic and international) and there’s pressure from all capital sources to invest in North America. Industrial is an attractive asset class right now, but because there is a lot of capital to be invested in assets from coast to coast, prices continue to increase across the board. We’ve experienced this over the course of the last few years.
Moore: Demand for industrial properties in the investor marketplace continues to be very strong, as it has been one of the top performing real estate sectors for some time. Given the exceptional rent growth our sector is enjoying, investors are attracted to the opportunity to drive incremental cash flow from increasing rents vs. expiring rates. Incremental demand has been meeting or exceeding demand for a number of years, driven by e-commerce and supply chain investments across a broad range of industries. This breadth of demand gives many investors confidence that they can re-lease their building in the event of a vacancy. In addition, development is constrained in many markets due to the lack of available entitled land. While rising interest rates might impact the investment decisions of certain levered buyers, the overall buyer pool remains very deep for single assets or portfolios.
Chicago Industrial Properties: What kind of industrial properties make for the best investments and why?
Crawford: The best investments are a function of location, quality and price. A high-quality building in a poor location and at a high price is not as attractive as a lower quality building in a good location at a reasonable price. Understanding the markets and pricing across those markets has allowed us to find great investment opportunities nationally. We like the risk adjusted returns in development. We have extensive experience and success in development, and we are achieving premium yields. When acquiring existing properties, we are looking for shorter term leases so that we can roll them to market. Also, we look at properties that we can buy close to land value, giving us more flexibility as the leases expire – we can lease again or redevelop the property.
White: Industrial subsectors are in high demand right now, and a lot depends on the market or submarket where the assets lie. There’s a high demand for million-square-foot distribution and fulfillment centers on the West Coast. Other markets like Jacksonville or Memphis are more conducive to flex or multi-use logistics. What gets the headlines are million-square-foot warehouse or fulfillment centers that are occupied by large companies like Amazon, Target or any 3PLs that set the space on behalf of their clients.
Moore: We are focused on driving long-term cash flow from our investments. Our philosophy is to focus on high quality, well-located properties in supply-constrained markets and submarkets that can serve the needs of a wide range of customers for industrial space. When building or buying a property, we want to ensure they have key features like excess truck, trailer and car parking, as well as wide turning radiuses. Efficient highway access and a talented labor pool are also considerations. These features will help our buildings perform throughout the business cycle. With much of our investment being done through development, our new state-of-the-art buildings require limited capital expenditures for many years, contributing to our overall cash flow growth.
Chicago Industrial Properties: What makes Chicagoland an attractive place for investors?
Crawford: Chicagoland is one of the largest industrial markets in the country. It has the third largest population in the U.S., and approximately 270 tons of goods moves in and out the market annually. Recently it has seen significant net absorption pushing vacancies lower and rents higher. Chicago’s market size, distribution infrastructure and status as the largest city in the Midwest make it an important market for institutional investors.
White: Chicago is the largest market in the U.S. at 1.3 billion square feet. It’s in the epicenter of the country. All railroads run through Chicago, and its location alone makes it a viable location for any developer or investor to place capital. Just in the last quarter, CBRE indicated that there was about 94 million square feet absorbed throughout the country, and of that, 10.5 million was absorbed by Chicago alone. We’re experiencing good rental growth in our properties in Chicago, and I think that’s going to continue. The demand is certainly there.
Moore: Investment drivers for the Chicago market are its position as a significant consumption zone and critical transportation hub for the nation. With six Class I railroads serving the area and O’Hare as the fourth busiest air cargo hub in the nation, many goods go to or through Chicago. The size and depth of the investment market for properties in Chicago drives strong demand from institutional and local investors, making it a very liquid and efficient market.
Chicago Industrial Properties: Where in Chicago have you invested? Where in Midwest?
Crawford: In Chicago, Duke Realty is focused on infill opportunities. We’ve found that many of our clients want to be near the millions of consumers they serve so we have scoured areas like Bedford Park, Cicero and around O’Hare for amazing sites. At the same time, we have continued greenfield developments in both the I-55 and 88 Corridors where demand continues to be strong. Duke Realty is also very active on the development front in Indianapolis where we have three speculative projects underway and in Columbus, Ohio. Additionally, we have robust, well-established portfolios of existing properties in Minneapolis and Cincinnati.
White: Chicago is our largest market, but we’re in other markets in the Midwest. We’re also in markets in Ohio, like Cincinnati and Columbus. The industrial marketplace is as robust and has some solid tailwinds behind it right now. I expect it to continue to grow, and we’re bullish on the on the overall asset class and the markets that we’re in.
Moore: We currently have a new 451,000 square-foot development underway in the Kenosha market. This will be our third building in our First Park 94 project and our total investment in this building will be $38 million. Completion is slated for Q4 of this year and the facility will be a perfect home for tenants serving the Chicago and Milwaukee consumption bases and the greater Midwest, with easy access to I-94. We can also accommodate up to 2.6 million square feet of future development at the park, either through build-to-suits or future speculative projects.
We are also excited about two buildings we have underway in Nashville. The first is a 692,000 square-foot build-to-suit for Chewy, the online pet food and supply leader. The second is a 500,000 square-foot project in lease-up that will be ready for occupancy by Q3 of 2022.