American Realty Advisors


Market Commentary, June 15, 2022

In Conversation: Industrial Real Estate

ARA CEO Stanley Iezman and Head of Research Sabrina Unger discuss the drivers of the industrial sector’s recent run-up and what may lie ahead for this top-performing sector. They explore the role of the pandemic in accelerating e-commerce demand, how robotics may influence site selection, and where we see current and future opportunities to invest. 


Stanley Iezman: We have been investing in industrial properties since the inception of the firm. We’ve seen just massive growth in the demand for industrial properties throughout the country. Why don’t you give our investors a little background in terms of what’s driving this and what are the characteristics of that demand?

Sabrina Unger: I think what everyone sort of expects is the answer—and it’s true—is that it’s largely being driven by e-commerce. So fundamentally, distributing goods from a warehouse is different from sending it via the store, and a lot of retailers have had to up the amount of space they have to occupy in order to service same-day and next-day delivery. It has really been insatiable demand from those tenants.

SI: Let’s talk about last-mile, in terms of what it means for investors and how we should be thinking about that subsector of industrial real estate.

SU: Last-mile has really become this buzzy word that everyone who is trying to sell an older industrial facility is using in their marketing packages. The reality is that “last-mile” is really the last touchpoint between the distribution and the end user. So whether that’s coming to your house via an Amazon package, if the last-mile is from the warehouse to a store or a business, and what’s funny about that is that it’s not really a mile. It can be five miles it can be 15 minutes, it can be half an hour, so the definition of “last mile” in a given market can vary materially. Now what we’re talking about in terms of physical structures is often older product, because that’s what exists in truly infill locations. So when we think about cities like Los Angeles or New York, we’re trying to get as close to the rooftops as possible—we’re trying to cut down on the transport cost that our occupiers are paying in order to distribute goods. And they’re willing to pay higher rents in order to be closer—that’s really what we’re talking about when we say a last-mile facility.

SI: We joke about how, when I order something now, I expect to get my delivery 20 minutes later. Explain the role of consumer here, and what’s happening as they expect more and more speed in e-commerce delivery.

SU: If you look over time, the expectation was, five or 10 years ago, if you got something you ordered online in two to three days, that was really fast. Fast forward to the pandemic, and we wanted things the next day, or same-day, and now occupiers are trying to get ahead of those consumer demands to be able to deliver within an hour or 20-minute window—and that really forces occupiers to get as close to their end-user as possible.

SI: Rents continue to climb—should we be concerned about that? Are we going to get to where rent for an industrial building is more than an office building in urban areas?

SU: I think what you’re implying is that the value of offices would have to go down quite a bit, and the value of industrial would have to increase quite a bit. I think we’re quite a ways away from tipping that equilibrium point. But what I will say, in terms of rent growth, is that the demand has really just been insatiable. Anyone who has lived through several industrial cycles will say that supply will eventually begin to overtake demand and begin to moderate rent growth—we’re now nine years into this industrial bull run, and to date we really haven’t seen any pockets where supply is overreaching demand. As long as those conditions exist, we’ll continue to see very robust rent growth.

SI: Are you concerned that this backdrop is going to result in additional development in urban areas next to houses and that communities may start to react negatively to this?

SU: I think for that to happen, there has to be space to be able to develop. So when we think about a lot of cities, or dense municipalities, there really isn’t the space to be able to develop those buildings. You may start to see pushback from communities that don’t want these facilities in their backyard, as investors and communities start to focus more on ESG they might become focused on the amount of truck traffic or emissions that are coming out of these so what that could mean is actually less supply going forward in aggregate, but that also suggests higher rent growth, because the demand is not going to dissipate.

SI: What impact has Covid-19 had on industrial real estate?

SU: I would say it has accelerated the demand for industrial. If you look at e-commerce as a percent of total retail sales, it really spiked early in the pandemic. During lockdowns, people who maybe had otherwise never purchased goods online or only a few times a year were suddenly relying exclusively on these retailers to be able to order online, have things delivered safely, avoid the grocery store, and while we’ve seen that e-commerce penetration rate normalize a little bit, it’s still above what the pre-pandemic trendline would have been. We’ve experienced an acceleration, and almost a bring-forward of that e-commerce demand by virtue of the pandemic, so it’s one of the few sectors that has actually benefited from the environment.

SI: Supply chain disruption has been top of mind, which has brought on the topic of on-shoring and re-shoring. Do you think this is real, or is it hyperbole?

SU: I think anecdotally, you are seeing certain companies bring parts of their manufacturing back to the United States, whether that’s by virtue of supply chain delays or whether they’re just not able to get their goods fast enough, so they’re making large capital commitments to be able to manufacture parts of their products here in the United States. The reality is that globalization occurred over the course of several decades, and it was a very thoughtful approach. It combined the cost of labor, how long it takes to get goods, and so it’s not easily reversed, and it’s not quickly reversed. While we may see a gradual reshoring of certain parts of the manufacturing supply chain, I do continue to think that globalization remains supreme in that regard.

SI: Let’s talk about labor and robotics. How are tenants thinking about balancing capital spend on robotics as labor supply tightens?

SU: I think a lot of industries, including warehousing, have faced labor shortages, particularly during the pandemic. People don’t want to be working close together, if people get sick, they miss shifts, so that’s a real challenge for the warehouse space. The reality is that robotics as a penetration is still very low in warehouse. Less than 10 percent of warehouses that have really deployed automation, so there’s a huge upside for companies to be able to leverage that incrementally. What’s prevented them from doing that thus far, at least historically, is that there was ample labor and therefore there wasn’t a huge incentive to implement technological advancements to offset that. Now I think you’re going to see an acceleration of technology adoption to offset this tight labor market. Ultimately, I think there might be a little bit of a pain point in the near term as companies adjust and figure out their spending, but that technology can help supplement what they’re not getting in the traditional labor force, and so that might ease some of their constraints in terms of what markets they may be willing to go into.

SI: Where do you think that values in industrial are going?

SU: I think what we saw in 2021 was just astounding, it was a record-breaking year for total returns for the industrial sector. We do expect those returns to moderate, but still be far and above the strongest property type in terms of unlevered returns. For this year our expectation is for total returns to surpass 20% again, for another very strong year for industrial.

SI: Do you think there’s an opportunity in suburban office, an older, traditional two- or three-story office building, to be converted into a multistory warehouse industrial property?

SU: I don’t. I think what you would see in terms of multistory development is a select number of markets where land values have become so expensive that you have to go up instead of out. But there are a lot of technical elements that make multistory warehouses somewhat more challenging for users to use, get used to—they have to learn how to operate in these spaces because it’s relatively new in the United States. To take an existing building that was built for another purpose and try to repurpose it for multistory, I think you’d be very challenged to have that functionality. You’d probably be better off trying to build a multistory warehouse from scratch.

This transcript of the ARA In Conversation discussion has been edited for clarity.

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