Publications

- January 1, 2019: Vol. 6, Number 1

The last mile proving to be CRE’s green mile

by Danner Hickman

Over the past decade, industrial real estate has reached a remarkable level of performance and success. Rents have risen rapidly, vacancy has plummeted, and demand has outstripped supply. Investors are enthusiastically rushing into the space, establishing it as one of the most desirable commercial real estate asset classes. And the enthusiasm shows no sign of waning — both long-time industrial investors as well as newcomers expect the extraordinary industrial expansion to continue into the foreseeable future.

The industrial surge can largely be attributed to growing e-commerce and omnichannel platforms, whose expansion has propelled a thriving demand for distribution and warehouse facilities.

E-commerce retail sales are growing at double-digit rates and currently make up about 10 percent of total retail sales. While shoppers buy goods online from a variety of sources, Amazon.com Inc.’s Prime service and One-Click ordering have made it easier than ever before to have goods delivered to one’s door. There are already more than 100 million Amazon Prime members in the United States, and Amazon transactions alone are expected to comprise roughly 50 percent of total e-commerce sales by the end of 2018. By 2021 there are projected to be more than 230 million digital U.S. shoppers, and they will likely buy a higher percentage of goods online than they do today.

The need for industrial real estate is not only driven by the accelerating volume of goods sold online, but also by the way inventory is handled in warehouses. According to Prologis, the largest owner of industrial space in the world, products sold online require three times as much warehouse space as those sold in brick-and-mortar stores. Products delivered to a store can be held on a pallet in bulk and shipped together, but products sold online must be individually packaged and shipped to consumers, requiring more floor space.

Last-mile industrial facilities have recently dominated demand, as tenants pivot away from the stereotypical big-box industrial mega-centers to smaller, more urban buildings that are better positioned to provide rapid delivery to consumers. Solid performance and operational upside have attracted significant competition and investor interest to last-mile properties. In response, construction of small- to mid-size facilities grew to represent more than 80 percent of total industrial development in first quarter 2018.

This high demand for closer-to-consumer space combined with ever-growing e-commerce channels has created an atmosphere built for strong industrial performance. Industrial vacancy rates reached an all-time low of 4.8 percent in the past year, a number that has declined by more than half since 2010. Growing competition and increased demand for this type of space has turned these historically less-attractive assets into some of the most sought-after real estate on the market. As a result, industrial rent prices and property values are spiking. These trends are expected to continue along their paths if demand remains strong and, with more than 30 consecutive quarters of total new leases outweighing new vacancies and e-commerce growing as it has, demand does not show signs of diminishing anytime soon.

There has always been investor demand for industrial assets, but recent trends have significantly enhanced its appeal as an asset class. The net-lease industrial market is also receiving notable investor interest as its performance parallels that of the overall industrial market. Investors especially value the long-term leases, contractual rent increases and predictable cash flows associated with net leases. Steady rent growth combined with climbing asset values and low cap rates have been the results of substantial and growing demand for net-lease industrial assets, as evidenced by Blackstone’s recently announced acquisition of Gramercy Property Trust for $7.6 billion.

Industrial real estate is expected to continue its strong performance in 2019 and beyond. The sector’s seemingly parallel growth with that of e-commerce is a strong indicator of future health, given the thriving predictions for the e-commerce sector. Strong returns and a positive outlook have positioned the industrial asset class to continue to attract significant investor interest from both home and abroad. With positively trending fundamentals and healthy demand, the future of the sector appears bright.

 

Danner Hickman is vice president of research and analysis at Broadstone Real Estate. This article originally appeared on Broadstone.com.

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