The COVID-19 pandemic has caused virtually everyone involved with commercial real estate to pause and reassess their situation. For many in the industrial asset class, however, there hasn’t been time to pause as they’ve never been busier.
There’s no question that the novel coronavirus has realigned paradigms across every corner of the economic spectrum. In the industrial sector, this new reality and uncertain future has left some optimistic, others cautiously so and, unfortunately, created a bleak future for a minority.
“Overall, I’m pretty bullish about what things are going to look like on the other end of this,” said Joshua Hearne, SIOR, principal at Cawley Chicago. “I’ve been surveying different clients and the most of them tell me that 75 to 80 percent of their industrial portfolio is still in there and operating at some capacity.”
There are essentially three segments of industrial users right now: those that are thriving as a result of the pandemic, those that are treading water in anticipation of a rebound and those that simply won’t make it out of this situation in one piece.
The first group, largely made up of e-commerce and logistics firms, might be looking for some short-term expansion space right now. The second group might be asking for rent abatements or other help from their landlord.
“There are a couple groups, unfortunately, that are struggling and that might not make it to the other end of the tunnel, but I don’t think that there’s very many in that last category,” said Hearne. “Most people that I’ve talked to are pretty optimistic and can see the light at the other end.”
There is a sizable portion of the population that, until the pandemic, were late adopter to online shopping. COVID-19 forced their hand, however, and they are now getting a taste for the convenience that it brings. Once the economy recovers, these consumers may return to brick-and-mortar stores, but they likely will be new converts to e-commerce for much of their shopping.
“As strong as e-commerce was going into this, I think it’s going to be even stronger coming out of it,” Hearne said. “I think we’ve catapulted e-commerce ahead five to seven years.”
As a result, logistics firms are looking to pack in as many able-bodied workers as they safely can in six-foot increments, since they have largely seen an uptick since the beginning of the lockdown. Many without a strong e-commerce component to their business are working with limited staff or expanded shifts, but their continued activity is proof that there’s been little if any cutback in demand to move products to the consumer. For others, such as companies working in or serving the trade show, airline, restaurant and other industries, prospects are admittedly gloomier.
Cawley Chicago research indicates that industrial vacancy in the overall Chicago market rose to 6.3 percent, up from the 5.9 percent at the end of 2019. They forecast that the metro vacancy rate could stand at 6.6 percent by end of 2020, representing 85 million square feet of vacant industrial space.
There are currently 17 million square feet of industrial product now under construction in the Chicago metro. This space is currently 39.3 percent pre-leased, below the 50 percent pre-leasing rate that most developers deem a healthy ratio. However, Hearne feels that all things considered, that figure isn’t too worrisome.
“What you really want to watch is the time on market for new, speculative development. If that metric starts to linger too far without some absorption happening, that’s when there’s going to start to be an imbalance,” said Hearne. “For the past 12 to 18 months, absorption has outpaced the supply so if you start to see supply outpace the absorption, that’s when you know that’s when we start to worry a little bit.”
The majority of new spec development is, unsurprisingly, focused in the I-80 and I-55 corridors where nearly 5 million square feet across 17 buildings are now under construction. Only 28.4% of that space is pre-leased. But Hearne remains confident, even in these spec submarkets.
“Every industrial developer that I know of is still super bullish because they know that if they throw the shovel in the ground this spring, they’re not delivering until mid-2021,” Hearne said. “Between now and then, there will higher demand for e-commerce-related space.”
Lenders appear to be open to financing industrial deals at the moment. The one caveat being that—with the influx of Paycheck Protection Program requests and so many bank employees working from home—it may take longer to put a loan together.
“There is a little bit more cautionary red tape as they make sure that a borrower has a balance sheet that can support it,” said Hearne. “But overall, if it’s a stable company that they view will survive a short-term blip, then they’re not going to hesitate in providing them the funds that they need to press forward.”
Portfolio buyers are a slightly different breed. Some have delayed closing a deal in hopes that if they hold out for a month or two that they may get some sort of rebate because of the COVID-19 situation. Sellers are treading carefully too, anxious that their tenants’ financial situations—real or perceived—might shut a deal down.
“I haven’t seen a lot of packages go out for sale,” said Hearne. “They know that they if they put a portfolio on the market right now and a couple of their tenants start waffling during the process, it’s going to show a blip on the cash flow sheet.”
Acknowledging that the COVID-19 situation may cause a prolonged economic slowdown, demand for Class A industrial space is simply too strong for any enduring adverse effects. Additionally, most of the players in these arenas are institutional, so they’re very well capitalized. That’s not to say that there aren’t some jitters out there.
“Some would bend over backwards and do a deal for 25 cents to 50 cents a square foot below market with some sort of heavy free rent period up front, just to be the one to get a warm body in the door,” said Hearne.
There has been speculation that once the economy reopens and rebounds, we might see a re-shoring of manufacturing and pharmaceutical jobs. The overseas supply chain, especially with China, has become so attenuated that many corporations may opt to bring those jobs back to U.S. soil where they can better control the flow of products.
As hard and fast as pandemic countermeasures have caused dysfunction in our markets, it’s difficult to hold out hope that we aren’t at the start of another recession. But most experts remain confident that strong fundamentals are still in place and—assuming we can return relatively quickly to something approximating a normal, functioning economy—the velocity of activity we have become accustomed to the last few years may not be far off.