The commercial real estate market is heating up and industrial property is playing an increasingly important role in the supply chain
The commercial real estate market is heating up and industrial property is playing an increasingly important role in the supply chain
How is the industrial property sector faring following a period of strong performance during the pandemic?
Let’s start with the context in which investors are looking at the industrial and retail sectors. Demand for industrial property, particularly warehouse and distribution facilities, has been driven by many factors in the last few years, including the increasing share of e-commerce as a percent of all retail. Improvements in supply chain management – in transportation and distribution infrastructure, including port expansions – have also helped these properties, as competition to deliver purchases to consumers and businesses more quickly increases. Additionally, the general growth in the economy is, as always, another major factor.
Is there concern that the industrial property sector will become bloated and oversold, much like retail properties?
Distribution facilities don't rely solely on e-commerce as the goods in brick-and-mortar retail and business-to-business commerce are also traveling through the distribution channel. These demand drivers existed pre-pandemic and will continue for the foreseeable future. This contrasts with the physical retail sector, which has been severely overbuilt for decades and is experiencing waning demand for the typical goods and services offered. The supply and demand dynamics are completely different.
With the above context in mind, investors still need to pick their spots in a very hot industrial market carefully. With capitalization rates very low and valuations well above their pre-pandemic levels, there isn’t a lot of room for error. Future returns will be generated from continued rent growth across the sector, which is not expected to slow down any time soon. Overbuilding will eventually curtail that growth, and it is starting to happen in certain markets.
We all know real estate is cyclical, and the cycles are often caused by developers all responding to demand at the same time and creating excess supply. According to some estimates, there's 400-500 million square feet of new supply in the pipeline. The smart money is focusing on urban infill and transportation hubs. But not every market needs more product, even with incredibly low vacancy rates across the US. While most of the pipeline will likely be absorbed as increased demand outstrips new supply, we expect to see vacancy rise in overbuilt sub-markets.
Will potential issues with the supply chain in the US, reportedly at risk of being affected by huge backlogs from Southeast Asia, have any specific impact on the long-term prospects of debt investments in these properties?
The current supply chain issues, while complex and significant, are likely transitory and shouldn’t diminish the overall trends cited above. Overall, the asset class is performing very well, with above-average growth in cash flows which is expected to continue for several years. This is readily seen in the performance of debt secured by industrial properties, where the delinquency rate of loans in commercial mortgage-backed securities (CMBS) is below 1%. That compares to an average of over 5% across all CMBS loans. As of today, lenders are very eager to find industrial deals. Of course, underwriting construction loans must reflect that any imbalance in supply and demand in the specific market is being analyzed.
Where does the industrial sector fit within the PERE debt risk/return spectrum and what are its specific diversification benefits to a broader real estate portfolio?
Alternative real estate investments in the current market can be bifurcated between low-risk/low-volatility and high-risk/high-volatility asset classes. In the first category, we certainly have industrial, as well as multi-family and single-family rental, self-storage, and manufactured housing. The higher-risk category includes offices, many forms of retail, and the hospitality sector. That’s not to say there isn’t money to be made in any of these categories, just that the investor needs to be adequately paid for the risk. Right now, most industrial plays, including private debt, are bond-like investments at a time when corporate and government bonds have no yield, and so the relative value is very attractive. The key is selecting the properties with the right characteristics (e.g., access, adequate number of bays, heights of bays, technology) in the right locations, where reasonable leverage and rent growth will produce above-average returns.
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About Joe Rubin
Joe Rubin is currently a consultant to the firm’s Financial Advisory Services Group focusing on real estate clients. Joe has over 35 years of experience in the real estate industry supporting his clients’ most important decisions. He has worked with family-owned businesses, REITs, private equity funds, and financial institutions to develop strategy, improve governance and operations, and manage risk.