The outlook for capital markets and industrial real estate
Posted November 12, 2021 By Shawn Moura, Ph.D. And has no comment
Low cap rates and rapidly rising rents reflect industrial real estate’s status as the leading sector in commercial real estate development. Record levels of capital are flowing into industrial real estate, while tenants are willing to pay higher rents to secure additional inventory and shorten delivery times. Kevin Welsh, Executive Director at Newmark; Juan Arias senior consultant at CoStar Advisory Services; Jim Clewlow, chief investment officer at CenterPoint Properties; and Mary Lang, head of America’s direct logistics strategies at CBRE Investment Management, discussed current trends in capital markets at I.CON East 2021 in Jersey City, New Jersey this week. The panelists shared their views on the impact of low cap rates, rising rents and a shift in both investors’ and tenants’ priorities on investment in the industrial sector.
Panelists agreed that the recent strength in the industrial sector is the product of structural changes in the US economy. Clewlow recalled that years ago, industrial end-users were primarily concerned with cost control, moving further and further away from major metropolitan areas in search of lower rents. The acceleration of e-commerce has changed that dynamic, so that distribution costs are now more important than rents: “We all know that logistics costs have a major impact on our users and their bottom line. That’s why I think the calculus has changed,” he said.
Lang noted that recent disruptions to global supply chains have only increased retailers’ tolerance for higher industrial property costs. Retailers know that inventory shortages can hurt their brand and push customers to shop elsewhere. As long as the customer experience is a major driver of a retailer’s revenue, they will be open to paying the additional costs associated with holding higher inventory.
Nevertheless, while end-user priorities have shifted, the fundamentals of real estate still matter. Clewlow pointed out that “really good and well-located real estate will always be valued more.” However, Arias notes that what qualifies as a good location has also shifted considerably in recent years. Locations adjacent to ports, intermodal facilities and rail have seen the strongest rental growth and are where investors are most comfortable buying at lower cap rates. Likewise, investors are primarily focused on the largest, best-performing industrial markets. Lang said she expects industrial rents to grow 25-30% (or 5-7% per year) over the next five years in the 15 key industrial markets targeted by CBRE Investment Management.
Welsh asked the other panellists about their perspectives on investing in a low interest rate environment, where yields have continued to decline in recent quarters. Panelists noted that while caprates are a useful measure, developers and investors are more focused on whether an individual project meets or exceeds a required internal rate of return. Clewlow noted that traders developers have a different cost of capital and higher threshold than those who work primarily for large institutional investors. The number of years that capital is available for a project also affects the returns developers accept for a project. CenterPoint Properties, which is owned by the CalPERS pension fund, has a very low cost of capital and a patient owner, and can invest in high-quality projects with a lower capital rate and strong long-term potential.
Arias noted that international investors who have a low cost of capital and a higher tolerance for lower yields have been drawn to the US industrial market and are contributing to the decline in cap rates. As Asia and Europe are way ahead of the US in e-commerce adoption, these investors are already familiar with the industry and feel comfortable making major investments in US e-commerce facilities now that the US adoption accelerates. reassuring that US e-commerce demand will soon match or exceed levels in Asia and Europe. “I never want to underestimate our ability to want things as quickly as possible… As a culture, we desire everything yesterday.”
Recent widespread price increases have led some to question how inflation could affect the industrial sector. Clewlow found that commercial real estate has historically acted as a hedge against inflation and that industrial real estate could attract more investor attention in the near term. However, a prolonged rise in inflation could have more negative macroeconomic impacts that could hit the sector. Recalling earlier episodes of high inflation in the 1970s, Clewlow noted that continued high inflation leads to higher levels of economic uncertainty and investor indecision, which can significantly hinder new development.
Arias answered a question from the public as to whether spending on President Joe Biden’s recently passed infrastructure bill could contribute to higher inflation. Furthermore, investments in key infrastructure, such as ports, could help alleviate some of the supply chain congestion that is currently the main driver of rising prices. Lang said she is less concerned about the bill’s effect on inflation than about the possibility that spending will exacerbate labor shortages in the logistics sector. She said she suspects many current and potential logistics employees could be attracted to new jobs in infrastructure construction.
Panelists also pointed to Amazon’s recent shift from leasing to buying or building its future facilities directly. Clewlow doesn’t expect this shift to materially affect demand for industrial real estate as long as Amazon takes up more space. Arias shared his predictions that Amazon will build at least another 250 million square feet of industrial real estate in the coming years, on top of the approximately 300 million square feet currently in its portfolio.
As NAIOP Research Director, Shawn Moura leads the NAIOP Research Foundation’s research committee and the day-to-day operations of the Foundation’s research projects.