IllinoisIndustrial The state of the industrial market Whitney Carlisle May 2, 2019 Share on Facebook Share on Twitter Share on LinkedIn Share via email A panel of real estate brokers, investors and developers essentially all agreed that the industrial marketplace continues to flourish, surpassing just about every growth and expansion metric conceivable. The panel was convened at the 16th Annual CIP Summit, hosted by REjournals and I had the pleasure of moderating a panel of six talented professionals with expertise ranging from brokerage to investment/ownership to development and construction. David Friedland, executive director of Cushman & Wakefield, suggested that if he had to pick whether the market is in extra innings with the potential to experience an abrupt ending or in the middle of a double header, he’d say, “Chicago is in the midst of a double header, with plenty of playing time left in the game.” Brian McKiernan, Sr. vice president, Centerpoint Properties, was more tempered in his view of the marketplace. He specifically cited construction costs that are escalating at double-digit increases and rents that are “at a 20-year reset” as among his concerns. “From an ownership/investment perspective you have to ask the question, ‘how do you invest,'” McKiernan said. “I don’t think it’s a dire situation, but there will be a value reset occurring sooner rather than later. Sometimes the ownership model is a struggle.” Chris Gary, an executive vice president with NAI Hiffman, gave a more bullish outlook of the industrial market and said, “Chicago is a very efficient market.” He explained that further by saying that, in general, demand is keeping up with supply. Taking a realistic view, Matt Goode, a principal with Venture One Real Estate, said, “industrial real estate will suffer when the rest of the economy suffers, but I just don’t see the disruptor that will cause that.” Goode admitted that sometimes that’s when disruptors often occur, when people least expect them, but right now he remains confident that industrial real estate will continue to outperform and be a good place for people to invest. Ben Harris, senior development manager, Conor Commercial, cited a UBS report that noted e-commerce is expected to continue to grow, increasing its market share from 15 percent of sales to a robust level of as much as 25 percent. “In retail/e-commerce, technology and logistics are getting better and better all the time,” Harris said. “Until retailers figure out the right mix of clicks and bricks, the market should perform well.” Goode echoed the sentiment of others when he said, “the e-commerce tail wind will continue to help us.” In the hour-long session, the panel delved into where they see emerging and sustained growth opportunities, and how the market is changing, in a strong business climate. Tim Hennelly, the president of the Great Lakes region of Ryan Companies, addressed the emergence of Opportunity Zones (OZ) as a tool that likely will encourage development in certain areas and broaden the depth of the market. Hennelly noted that Ryan is preparing to break ground on a 400,000-square-foot spec building at Pullman Crossings, just south of the Loop in the Pullman area. He pointed out that Ryan already was pursuing a spec development option at Pullman before the area was designated part of an OZ. Given the newness of OZs, and some of the uncertainties that exist now and could arise over as the opportunity unfolds, some panelists questioned the likelihood of the overall success of the investment tool. Gary, who said OZs generally represent a great potential opportunity, noted that traditionally, companies go where the transportation and labor are good. “Pullman is a good real estate play, with strong overall fundamentals,” Gary said. But he also noted that when incentives are the sole or primary driver of a development, you can have problems. Hennelly agreed and said that real estate deals like Pullman need to stand on their own, regardless of incentives, tax breaks or any other inducements that may be offered to complete a deal. He also said that he believes there will be other industrial developments that will be announced in OZs within Chicago. Goode, noting some of the uncertainties that could emerge, said, “In five to 10 years we could be seeing some distressed Opportunity Zone properties hit the market.” The panel also explored how tenant demands in the area of building amenities, office build-out requirements and parking are changing. One of the challenges of the market today, according to Harris, is meeting the changing needs of tenants which include office space requirements that could be as much as 15 to 20 percent, more car and trailer parking and a greater level of building/industrial park amenities. “The challenge for developers is keeping their overall costs down when land and construction costs are both up,” Harris said. “It’s a question of how you make the deals work when TIs, which were once at $8 per square foot, are now at $16 per square foot.” Many in the market are witnessing what they see as a greater emphasis on smaller buildings rather than the million-square-foot behemoths that sit along the I-80 corridor. To the surprise of many, a lot of those buildings are empty. This leads the capital markets, among others, to ask if tenant behavior is changing. Harris cited research that found 80 percent of activity in 2018 was between 10 and 100,000 square feet. “I think smaller is better, and it’s winning,” Friedland said, proclaiming, “150,000-square-foot buildings are great!” Goode highlighted the “tricky dynamic” where investors are looking for the large buildings, but tenants are looking for smaller spaces. McKiernan concluded that now, more than ever, fundamentals really matter. Those fundamentals come down to the functionality of the space. “It’s an inflection point,” McKiernan said. “How well do we stick to the fundamentals?” One of the forces dictating the change in industrial real estate is very familiar to disruption: Amazon. Just as the company has changed the way people shop, it’s changing the way buildings are developed, and how they are used. “It’s the Amazon effect,” Hennelly said. “By its sheer size, everyone thinks Amazon is perfect for the big boxes. But they really have gone the build-to-suit route.” From an operational standpoint, Amazon relies heavily on the use of robotics in their warehouses. In utilizing robotics and other high-tech tools and racking systems, Amazon has become very efficient at maximizing the cubic foot. The overall impact of technology and the so-called Amazon effect could be felt for a long time to come. “When tenants are faced with a big box or custom solution, more are and will be taking a custom solution,” Harris said. When Hennelly, Harris, Gary, Goode, McKiernan and Friedland had wrapped up the session, most on the panel, as well as those in the audience, could relate to Friedland’s assessment of the market, “Industrial property has always been the ugly duckling in commercial real estate … but no longer!” For now, those in attendance and those at the dais seem content to bask in ongoing activity that characterizes the market. As Friedland offered, “there will be a recession, a downturn. We just don’t know exactly when!” In the meantime, enjoy the strength of the current market. Whitney Carlisle is a Member of the O’Keefe Lyons & Hynes law firm whose focus is on real estate property tax matters in Chicago, Cook County and the Chicago metropolitan area. Carlisle has 20+ years of varied and dynamic experience.