Mid-year review: How is the industrial sector coping with an onerous 2020? Matt Baker July 14, 2020 Share on Facebook Share on Twitter Share on LinkedIn Share via email The events that have occurred so far this year seem almost implausible and yet, as we are all painfully aware, they are very real. For those entrenched within industrial real estate, 2020 has provided plenty of unique—though not entirely insurmountable—challenges. “Clearly, no commercial real estate asset class is immune to the immediate and long-term impact of COVID-19, a black swan event unlike anything anyone has experienced,” said Tina Lichens, senior vice president, broker operations at LightBox. “Industrial real estate, however, is in the best position to return to a place of strength once we get past the short-term pain and uncertainty.” LightBox reached out to industry sources to gauge their sentiments on the industrial sector during the COVID-19 crisis. It is evident from their responses that the strongest asset class going into this situation is proving to be the most resilient during it, and most project long-term growth for the sector. At the midpoint of 2020, and several months into the pandemic, disruptions have hit all asset classes, and that includes industrial. The various lockdown measures instituted around the country (including the opening, closing and reopening of some states) has resulted in some supply chain interruptions. Additionally, many owners and developers have delayed new speculative developments as they await more stability in the economy. However, industrial is proving to be a tenacious sector. The rapid growth in online grocery shopping—as well as wider acceptance of e-commerce in general—has sustained demand for logistics space. Construction work has been deemed essential in most markets, so those projects that were underway or the few that broke ground during the pandemic have forged ahead. Morale on the ground The hardiness of this sector is strengthened by its ability to support multiple facets of consumer spending, leading to fewer long-term uncertainty. This makes it the clear top choice for investors over the next few quarters as they try to navigate a recession by focusing on deal velocity. “The good news is that the industrial markets were very healthy going into this crisis,” said Mark J. Duclos, SIOR, CRE, FRICS, the co-founder and president of Hartford, Connecticut-based Sentry Commercial, as well as the 2020 President of SIOR. “Some markets were overheating, but we saw the highest overall rental rates in the country and the highest occupancy rates in history for the industrial sector.” This renewed necessity for industrial space has not spread evenly across the sector. While demand is high for users in fields such as construction equipment and materials, e-commerce, groceries, medical supplies and pharmaceuticals, other sectors such as aerospace, automotive, oil and restaurant suppliers are feeling the pinch. Hopefully, those in-demand sectors will help the overall market tread water during this crisis. “Despite the severity of the current situation, there are bright spots and we will see a bounce back”, said Geoffrey Kasselman, SIOR, LEED AP, senior vice president and partner, workplace strategy at CRG. “It will trickle to a stream and then return to a river over a graduated period of time. Consumer spending is 70 percent of our GDP, so the big question is when will consumer confidence and consumer spending come back?” Citing data collected by CBRE, the Lightbox mid-year report identified positive benchmarks and projections for the industry as brokers, owners and investors seek out increased activity levels for the remainder of the year. For example, 16 of the top 20 construction markets still have active crews on site, though most new project starts were paused as of mid-May. Tapping into the CBRE data, forecasts predict a lull and then an upswing for various metrics. Vacancy rates, for example, will likely increase from their near record 4.5 percent levels as deliveries outpace leasing. After this short-term imbalance, pent up demand should see rates returning to pre-pandemic levels. Rental rates should see a similar trajectory. Rent growth, which had increased 4.8 percent year-over-year, will most likely flatten for a period of time before returning to that level toward the end of the year. “We are already starting to see tremendous pent up investor demand in the industrial sector,” said Jack Fraker, SIOR, vice chairman and managing director, capital markets at CBRE. “We expect that to lead to a strong second half of the year and into 2021.” Once the market stabilizes, Fraker expects national industrial rents and sales pricing to increase about 5 percent on average. Robust markets such as Chicago and Dallas should expect to see 5 to 7 percent increases while strong secondary markets, including Nashville, Indianapolis and Columbus can expect to see a rise of anywhere from 3 to 5 percent. Sources of growth Looking back on what made this sector so durable going into the pandemic, and seeing how it has responded to the crisis, it’s clear that there are a number of segments that investors are keeping their eyes on for the back half of 2020 and beyond. Last mile delivery. The desire to bring the supply chain ever closer to the end consumer propelled infill developments in recent years—a trend that only intensified under the strain of COVID-19. According to Avison Young research, asking rental rates can vary drastically in some markets when comparing last mile with outside the city core. Chicago and Nashville, for example, shows a 20 to 40 percent premium for last mile space. The long-term outlook for this segment is evolving but note that Amazon—which has more than 200 last mile delivery stations in the U.S. totaling 18.7 million square feet—is planning to create nearly 100 more similar facilities. Online food and groceries. Estimates indicate that food delivery doubled this year from 20 million households in February to 40 million in March, with 40 percent of those consumers being first-time online shoppers. Assuming most of these late adopters continue to order online, CBRE projects that this could lead to further demand for freezer cooler space of between 75 to 100 million square feet over the next five years. “Insurance” warehouse space. All one has to do is think back on the Great Toilet Paper Shortage of 2020 to understand the impact that the pandemic has had on inventories. According to Duclos, many industrial businesses are taking a closer look at their safety stock, ramping up inventory to prevent future supply chain disruptions. This will increase demand for industrial space in the near term, at least, though there could be long-term implications. CBRE estimates that inventory stockpiling could pump up demand for warehouse space by 5 percent over the next five years. Onshoring. So much of industrial real estate is tied to supply chains that, almost invariably, end with the consumer but begin with cheap labor in foreign countries. The largest source of this cheap labor, China, has caused consternation within many C-suites. From a risk management mindset, according to Anthony J. Lydon, CDCMP, national director, JLL in Phoenix, companies will look to mitigate that risk, while simultaneously shorting the manufacturer-to-consumer supply stream. While firms may still source materials internationally, he expects many to bring their manufacturing operations back to American soil, which will increase demand for appropriate industrial space. Data centers. The surge in employees working from home during the pandemic has illuminated a deficiency of bandwidth and mission critical backup storage for many firms. “With everyone working remotely, many companies didn’t initially have enough infrastructure to operate, which has unmasked notable capacity shortages in the data center market,” said Kasselman. Data centers, which historically have operated in the same geographies as warehouses and manufacturing facilities, are only going to grow hungrier for space as corporate users require greater cloud storage capacity.