Technology Industrial CCIM Feature

Industrial Rides High

E-commerce leads a roster of supporting players, contributing to its sustained growth.

The industrial market is riding the coattails of explosive growth occurring in the e-commerce sector. But while e-commerce may be grabbing the spotlight and stealing the show, a much bigger supporting cast of industries is helping to power this expansion.

E-commerce certainly deserves top billing for its role in not only fueling demand for space, but for spurring transformative change across the entire supply chain of modern distribution and fulfillment centers. This includes central hub locations that are within easy reach of both workers and the last mile of customer delivery. 

“The primary driver of industrial development has been the e-commerce sector in the Cincinnati and Columbus [Ohio] markets,” says Loren M. DeFilippo, CCIM, director of research | Ohio for Colliers International in Cincinnati. “Demand for modern Class A logistics facilities has driven vacancy rates to historically low levels.”

The Cincinnati metro area reported an overall industrial vacancy rate of 3.5 percent in first quarter 2017, with more strong demand ahead. Earlier this year, Amazon announced that it had signed an agreement with the Cincinnati/Northern Kentucky International Airport, and the online behemoth plans to invest $1.5 billion to create a Prime Air cargo hub that will include a 3 million-square-foot distribution facility and 350,000-sf loading wing, as well as creating 2,000 jobs. That hub is expected to attract more online retailers to the region, DeFilippo adds.

E-commerce, distribution, and third-party logistics continue to dominate the national industrial market, accounting for about 25 percent of all leasing activity, according to JLL. However, the lion's share of activity - the other 75 percent - is widespread across many sectors from medical device manufacturing to food processing.

“As a general take on things, the economy tends to be in a pretty good place, and a lot of businesses are benefiting from that,” says Ryan Severino, chief economist at JLL. GDP has been growing at a rate of 1.5 to 2 percent, and consumer spending remains healthy.

“I usually take the temperature of the confidence level of the principals of the company, and people are more optimistic,” adds Arnold Ng, CCIM, president of Apex Commercial Real Estate in Torrance, Calif. “They are not as resistant to expanding. They are willing to take on more risk, and people are being a little more aggressive in making moves.”

Industrial is outperforming other property types for vacancies and rent growth, and the latest forecast from the Spring 2017 ULI Consensus Forecast remains positive. Industrial vacancies are expected to improve 20 basis points to reach 8 percent by year-end, where it will hold steady in 2018 before climbing slightly to 8.4 percent by the end of 2019. Rent growth for industrial is expected to slow after peaking at 6.6 percent in 2016, but remain above the expected rate of inflation at 4.6 percent in 2017, 3.8 percent in 2018, and 3 percent in 2019, according to the ULI report.

Solid Foundation

Consumer spending is a big piece of the U.S. economy - a lynchpin in the demand for industrial space. It is important to note that despite the explosive growth of e-commerce, nearly 90 percent of all sales are still occurring within brick-and-mortar stores, according to Severino. Regardless of whether consumers are shopping online or in stores, that spending is fueling activity all through the supply chain from manufacturing and imports through distribution and logistics. 

“While consumers spend money, there is going to be demand on a whole bunch of different industries,” he adds.

Users looking for industrial space run the gamut from traditional manufacturers to nontraditional players, such as marijuana growers, churches, and trampoline parks. The nontraditional participants often seek to occupy industrial space, which is less expensive than retail, as long as they can pass the conditional use permit hurdles, according to Ng. “In our market, we have seen indoor sports facilities create demand for industrial as well,” he says.

Advanced manufacturing continues to be an important staple for the industrial market. For example, Ohio is home to operations for GE Aviation and auto manufacturers, such as Toyota and Honda. Those manufacturers attract demand from suppliers locating near their big clients.

“Automotive is stable right now, but we have to see what happens to the whole automobile industry during the next 10 years with the self-driving cars movement,” DeFilippo says.

Since 2012, available warehouse space has been dropping even as construction grows.

Spurring Growth

Edmonton, Alberta, has a robust industrial market with demand ranging from pet food to pot. Champion Petfoods recently announced a new 400,000-sf facility planned for the western part of Edmonton that will open in 2019.

Ford Canada also announced plans for a new 400,000-sf auto parts distribution center south of Edmonton in 2018, notes Carla M. Voss, CCIM, an associate at RE/MAX Commercial Capital in Edmonton. “As the economy in Alberta has been profoundly affected with the downturn in oil prices in the last three years, this has opened up different opportunities, such as the legalization of marijuana in 2016,” Voss says.

The marijuana industry is igniting demand for space near the Edmonton International Airport. For example, Aurora Sky is building an 800,000-sf owner/user distribution facility to be completed during fourth quarter 2017. The facility is expected to be one of the most advanced production facilities in the world, according to Voss. 

The legalization of marijuana is taking off in the U.S. with 26 states that currently have laws broadly legalizing cannabis in some form. Three other states will soon join them after recently passing measures permitting use of medical marijuana. Seven states and the District of Columbia have adopted the most expansive laws, legalizing marijuana for recreational use.

The marijuana companies typically are looking for large industrial warehouses for growing facilities, as well as processing, storage, and distribution. Companies are going into both new and existing facilities, as long as they have the correct zoning and are located the appropriate distance away from schools.

Certain cities are more friendly toward the emerging marijuana industry, and those cities and landlords that are more receptive to its use will attract demand and higher rents from these types of users as early adopters, Ng notes.

U.S. Industrial Volume & Pricing

All closed U.S. sales; cap rates augmented by refinance data.
2017 YTD data through May 2017

Year # Props $ Volume Avg Cap Rates Avg PPSF
2001 1,659 16,354,332,714 9.1% $53
2002 1,634 13,398,166,970 8.8% $48
2003 1,801 15,995,405,859 8.6% $49
2004 2,631 25,214,317,846 8.0% $56
2005 5,285 49,754,205,198 7.6% $60
2006 5,564 52,457,053,562 7.1% $67
2007 5,757 60,881,884,484 6.8% $70
2008 3,112 26,222,292,662 7.5% $66
2009 1,376 10,324,862,181 8.2% $55
2010 2,382 21,222,639,760 8.3% $53
2011 4,123 35,251,524,420 7.8% $55
2012 4,142 37,466,592,214 7.5% $59
2013 4,564 46,690,966,912 7.5% $63
2014 5,587 50,534,342,898 7.1% $68
2015 7,544 78,301,973,152 6.8% $74
2016 5,823 60,064,781,120 6.8% $78
2017 (thru May) 2,175 22,527,963,315 6.9% $83

Source: Real Capital Analytics, 2017

Top 10 Markets for Warehouse Space Under Construction

   Under Construction
 
  Existing Space
Availability Rate
 Market Space (sf)
Precommitted
Inland Empire, Calif. 24,442,934 27.0% 6.8%
Dallas/Ft. Worth 14,687,355 21.5% 9.1%
Atlanta 14,174,507 39.4% 8.8%
Pennsylvania I-78/I-81 Corridor 13,482,425 32.8% 8.7%
Chicago 10,393,149 51.3% 8.4%
New Jersey 9,169,747 43.3% 6.4%
Kansas City, Mo. 7,183,755 54.0% 9.4%
Los Angeles 5,796,992 26.9% 3.7%
Indianapolis 4,168,823 50.6% 8.5%
Denver 3,233,676 70.3% 9.3%
Total 106,733,363 36.4% -

Source: CBRE Research, 2017

New Supply

Construction ramped up during the last few years, and steady demand for development continues in the pipeline, especially from e-commerce, third-party logistics, and retail users. Almost half of the 167 msf of U.S. warehouse space under construction in the first quarter - 72 msf - is already precommitted to tenants, according to a CBRE report.

The top three markets for warehouse space under construction include:

  • Inland Empire, Calif., at 24.4 msf
  • Dallas/Fort Worth at 14.7 msf 
  • Atlanta at 14.2 msf

Construction of speculative distribution facilities in Ohio markets has increased in each of the past three years and will approach record levels in 2017. “Spec development has increased exponentially just trying to keep up with the demand,” DeFilippo says.

Cincinnati has close to 2.5 msf of new space coming online in the second and third quarters, with no preleasing. However, demand is still outpacing supply and continuing to push rental rates higher.

Investors also have an appetite to redevelop or repurpose obsolete buildings to create industrial facilities that are closer to the population for last-mile fulfillment. Much discussion has centered on whether vacant big-box retail stores, such as a Kmart or Sears, could be repurposed as industrial distribution and fulfillment centers.

Zoning and land costs are two potential stumbling blocks. However, there are cases where those conversions are moving forward successfully. For example, a shuttered Kmart was demolished in Cincinnati and replaced by a build-to-suit industrial building for a local supplier to the trucking industry.

In Cleveland, an Atlanta-based developer is looking at a vacant regional mall site on which to construct a 600,000- to 700,000-sf distribution facility for an undisclosed national company, DeFilippo notes.

Infill locations are attractive due to the high demand and barriers to entry for new competition. Historically, very few people worked in industrial warehouse facilities. Today, many individuals operate in these fulfillment and distribution centers, and they want to work in facilities that are close to amenities and are not parked out in a greenfield in the middle of nowhere.

“The employers, including Amazon, are going to look at space much the way an office employer does,” says Scott Crowe, chief investment strategist and portfolio manager at CenterSquare Investment Management in New York City. “How is this space going to help me attract employees, hire people, and keep them happy?”

For example, CenterSquare recently acquired a former Quaker Oats facility just outside of Harrisburg, Pa. The Class A industrial market is situated on all of the major road arteries, which make it very easy to reach the entire northeast within a one-day drive, Crowe notes. CenterSquare plans to completely gut the facility and raise ceiling heights.

“The way to avoid competition is to add value by accessing assets that need some form of transformation, active management, and capital investment,” Crowe says.

Although the pace of growth may be slowing, it appears that the stage is set for more expansion ahead, with developers, investors, and space users all remaining relatively active.

“I think we are years away from the end of the cycle,” Crowe adds. “And I think we are going to be surprised about how long the cycle lasts, because it has been a very muted recovery, and risk aversion due to the global financial crisis has forced a lot of discipline into markets in general, including commercial real estate.” 

Investors Strongly Support Industrial Assets

by Beth Mattson-Teig

Data that shows a decline in industrial property sales may not be an accurate barometer for the still-strong demand that exists in the marketplace.

After reaching a high of $78.3 billion in sales in 2015, sales dropped to $60 billion in 2016, and appear to have slowed further this year with year-to-date sales through May at $22.5 billion, according to Real Capital Analytics.

However, the 2015 sales volume was boosted by a few large portfolio deals. There weren’t as many of those portfolio sales in 2016, which makes it appear — artificially — that demand has dropped off, according to Ryan Severino, chief economist at JLL . In 2015, 45 percent of sales were fueled by large-scale transactions greater than $150 million as compared to 15 percent in 2016, according to JLL .

“There is still a lot of money that is interested in industrial, particularly in individual deals,” Severino says.

Investors like the fundamentals, and the forecast is for strong occupancies and rent growth to continue, even if there are some signs of slowing. Also, buyer demand is broad-based — coming from institutional and international capital — as well as owner-occupants and value-add investors that are looking to acquire and upgrade older assets.

Although single-asset deals represent the bulk of sales so far this year, some bigger portfolio deals have transpired. Recent notable sales included TA Realty’s sale of a 45-property portfolio of office and industrial properties for a reported $854.5 million. The Hampshire Companies also sold a 1.2-msf, six-building portfolio in New Jersey for $146.9 million.

Despite concerns about rising interest rates, investors are still  willing to pay top dollar for industrial properties. Cap rates held firm  at 6.8 percent in 2015 and 2016. Rates have inched nominally higher to 6.9 percent in 2017. However, price per square foot has been climbing since 2011. Year-to-date sale prices through May were averaging $83 psf compared to $79 in 2016, according to Real Capital Analytics.

Cap rates are getting close to the peak, but some industry experts believe there is still room for compression in many markets nationwide.

“Quality industrial assets are trading at increasing price levels,” says Loren M. DeFilippo, CCIM, director of research | Ohio for Colliers International in Cincinnati. Pricing also is motivating investors to expand strategies to consider new geographic markets.

As markets move closer to the peak, it is typical for investors on both the East and West Coasts to start looking in the Midwest and smaller secondary and tertiary markets where cap rates are higher, according to DeFilippo. That has certainly been the case in Cincinnati and Columbus, Ohio. “There are a lot of quality assets here and a lot of interest from investors,” he adds.

Continue Reading

Beth Mattson-Teig

Beth Mattson-Teig is a freelance business writer based in Minneapolis. 

 

 

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