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Warehouse Real Estate

No Recession for Logistics Real Estate in 2020

Feb. 10, 2020
Industrial and logistics real estate stays healthy, but will back off torrid pace of growth.

Industrial and logistics real estate growth will remain strong throughout this year, although it probably will not progress at quite the same torrid pace it has enjoyed in recent years, according to recent predictions by industry professionals.

“Over the next couple of years, we expect the North American industrial market to remain one of the leading product types to watch,” declares the global commercial real estate services firm of Cushman & Wakefield. “Economic indicators, with strong links to industrial fundamentals, point to continued growth in both 2020 and 2021.”

The forecast for North American industrial absorption in 2020-21 is a healthy 459.9 million square feet (msf). New supply—which finally surpassed demand in 2019—will continue to do so over the next two years, the company predicts. Supply levels are projected to reach 573.4 msf of new industrial product from 2020 to 2021. Nonetheless, North American vacancy will remain anchored around the 5% mark, ending 2021 at 5.2%, the company says.

It cited robust consumer spending supported by stable inflation, wage growth and low unemployment, which should bode well for industrial demand. “Barring any unforeseen risks, we assess that a recession will be avoided, thanks in large part to the stimulatory effects of the Fed’s rate cuts in 2019,” the firm states. “Resilient economic activity, strong property fundamentals, low interest rates and the relative attractiveness of real estate as an asset class are the primary factors supporting our outlook.”

Another trend driving demand for warehouse and distribution center space stems from structural changes wrought by e-commerce, with online sales projected to grow nearly 30% in North American from 2019 to 2021. “There is no doubt that increasing space needs associated with online sales, including those that are business-to-business (B2B), will continue to put pressure on occupancy and rent growth levels across North America,” C&W’s researchers declare.

They also believe industrial real estate will remain strong over the next decade as several of the largest metropolitan areas in the United States and Canada become even more densely populated. These include New York, Los Angeles, Chicago, Miami, Atlanta, Toronto, Dallas, Philadelphia and Houston. Among the industrial markets that will benefit from their proximity are California’s Inland Empire, Phoenix, central and northern New Jersey along with the Pennsylvania I-81/I-78 distribution corridor.

The fastest population growth is projected to occur in certain secondary U.S. and Canadian cities, including Orlando, Raleigh, Austin, Las Vegas, Calgary, Phoenix, Atlanta, Charlotte, and Edmonton. “These cities’ populations will grow nearly three times faster than that of the average North American city,” C&W explains. “As these cities’ populations increase, so will demand for industrial real estate.”

North American demand is expected to trail supply by about 54.2 msf in 2021, causing vacancy rates to rise modestly from their current record low levels. North American industrial asking rents are expected to increase by 6.8% and reach a new nominal high of $6.95 per square foot (psf) by year-end 2021—up from $6.51 psf in 2019—across North American industrial markets.

C&W forecasts that seven markets will register more than 10% rent growth from 2020 to 2021, with the top three being Canadian: Toronto (27.9%), Montreal (25.0%) and Vancouver (21.9%), along with Las Vegas and Ottawa (12.1% each), Providence (11.1%) and Boston (10.4%).

They won’t be alone. Other North American cities seen posting some of the strongest rent growth and the highest demand are Dallas/Fort Worth, Inland Empire, Atlanta, Chicago, the Pennsylvania I-81/I-78 distribution corridor, Indianapolis and central New Jersey, according to C&W.

Higher rents will occur in other supply-constrained markets, especially those close to ports (both inland and maritime), such as Los Angeles, Seattle, San Francisco Peninsula and Orange County. The markets being fed by the West and East Coast ports and intermodal hubs in the middle of the country are where U.S. rent growth will be strongest.

Is 2020 a Pivotal Year?

The global commercial real estate giant CBRE is just as optimistic in many respects but remains wary as well. It observes that 2020 could turn out be a pivotal year for the U.S. commercial real estate industry, with supply surpassing demand in at least some sectors.

In spite of some softening in the market, overall fundamentals will remain strong because of continued e-commerce penetration, which creates more demand for logistics services and infill properties. “Although there are potential trade-related risks, resilient consumer spending will buoy the industrial and logistics market and mitigate any tariff effects on major hubs relying on port activity,” CBRE says.

“Despite some softening in the industrial and logistics market, overall fundamentals will remain strong due to continued e-commerce penetration and demand for logistics space,” the company stresses, adding that as operations become more complex for occupiers, this will create fresh opportunities for well-positioned third-party logistics providers (3PLs).

Rent growth will be driven by newly constructed facilities and infill properties. Although there are potential trade-related risks, CBRE believes resilient consumer spending will buoy the industrial and logistics market and mitigate any tariff effects on major hubs relying on port activity. However, it agrees with C&W that industrial and logistics absorption gains will be limited this year and adds that available supply should outpace demand by 20 million to 30 million square feet—the first time this kind of overhang has existed since 2008.

At the same time, it also agrees with C&W that rents should be expected to rise by about 5%. “Anecdotally, we are seeing higher-than-normal renewal rates, particularly in the markets with the highest vacancy rates, and this trend should continue if not accelerate in the near term,” CBRE says.

In markets with fewer available spaces, these trends are driving increased focus on infill and smaller facilities. “High-quality, first-generation Class A warehouse space typically generates a rent premium, and demand for light industrial warehouses of less than 120,000 square feet will accelerate as e-commerce companies race to offer same-day delivery to customers,” the company explains.

In this regard, availability is destiny. It is these kinds of properties that have seen rent increases topping 30% in the last five years, while big box warehouse rents rose by 15%. Because available space is very limited in the smaller-sized segment, CBRE expects rent growth to continue over the next year.

E-commerce also is driving the trend towards adding facilities in more industrial hubs across the continent, especially in secondary markets, but they can be harder to target for investment because of their lack of liquidity. CBRE identifies Charlotte, Cincinnati, Denver, Louisville, St. Louis, Orlando, Tampa and Portland, OR, as key secondary markets offering strong liquidity and relatively high income returns in 2020.

Market Poised for Expansion

The global warehouse giant Prologis also posted a strong outlook, anticipating net absorption of between 250 msf and 275 msf of completions in 2020, which it says will keep the vacancy rate historically low at roughly 4.6% to 4.7%.

Prologis believes the U.S. logistics real estate market is poised for yet another year of expansion for several good reasons. “Logistics real estate demand was diverse and strong, supported by cyclical and structural trends,” it reports.

“Cyclical and structural growth drivers are incentivizing customers to invest in logistics capabilities to generate revenue and achieve operational efficiencies,” the company notes. “Supply is responding to years of strong demand, robust market rent growth and tight operating conditions.”

Last year, supply increased in locations boasting lower barriers to development, while the development pipeline in general continued to expand as a response to strong investor interest in logistics real estate, Prologis observes. But with much new supply remaining concentrated in these markets with lower development barriers, some of them face a real danger of being overbuilt, Prologis argues. Locations currently at risk of oversupply are said to include central Pennsylvania and the outlying submarkets in Houston and Atlanta.

The industry last year saw rental growth resulting from persistent scarcity and rising replacement costs, the company notes. These trends were exacerbated in the coastal metropolis markets that helped drive the 8% market rental growth in 2019. Prologis adds that land price spikes in particular pushed construction costs of logistics buildings to new heights in most markets, with the fastest growth in infill submarkets.

Overall, completions increased to 275 msf in 2019, up 3% from 262 msf in 2018, according to the company. Supply is expected to total 275 msf in 2020, largely because the volume of projects breaking ground stabilized in 2019.

With demand constrained by available capacity, net absorption is closely linked to new supply, and Prologis anticipates both will rise slightly in 2020. The supply and demand imbalance is primarily the result of frictional vacancy, which the company says happened in some situations where higher levels of new supply took extra time to lease up.

The national vacancy rate is expected to remain roughly stable in the near term, keeping the operating environment challenging for customers with upcoming requirements.

“Cyclical and structural growth drivers are incentivizing customers to invest in logistics capabilities to generate revenue and achieve operational efficiencies,” Prologis says. “Supply is responding to years of strong demand, robust market rent growth and tight operating conditions.”

Looking ahead, Prologis advises that its forecast of continued diversity in demand and sustained low vacancy makes advanced planning an ongoing priority for logistics customers.

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