Warehouses Outperform in Cloudy Commercial Real Estate Environment

Warehouses have been red-hot for a long time but show no signs of meaningfully slowing down.

Antonio Uve

Despite recent negative headlines surrounding the commercial real estate sector, there are still a few bright spots. Industrial warehouses are one of them. The sector has been red-hot for a number of years now and even with a slowdown in the number of new warehouse transactions, is still outperforming.


The latest report from research group CommercialEdge, shows that average industrial rents – including warehouses – have increased every month over the last year and stood at an all-time high of $7.15 per square foot as of March. Vacancy rates are also extremely low at 3.9%. Nationally, 636.6 million square feet of new industrial space was under construction as of March, including warehouses, according to CommercialEdge data.


Brian Lawrence, senior vice president and commercial real estate team leader at Univest Bank and Trust Co., expects that headline numbers like these will remain elevated over the near to medium term.


“We have seen a significant increase in demand for warehouse space with the uptick in use of e-commerce and delivery services since the start of the pandemic,” he says. “There are also a large group of CMBS lenders in this space including insurers and banks who are still transacting even though the cost of capital has increased.”


The growth of delivery services for things like groceries and household items is driving the need for so-called ‘last-mile’ warehousing, Mr. Lawrence said. These are warehouses that are within a 2-4 hour drive time delivery window and facilitate services like grocery delivery. “We’re seeing some of these facilities built on spec as they get approvals, which indicates confidence in being able to get tenants,” he says.


Stuart Katz, CIO at wealth management firm Robertson Stephens, believes this demand is part of a long-term secular trend. “Many people developed new habits during the pandemic and we don’t see them going back,” he says. “This was the case before the pandemic, but people spending so much time at home brought the trend forward a few years. The large coastal markets are leading the way in terms of total demand but we are seeing growth everywhere.”


Anyone who has been frustrated by having to track down a keyholder at a retailer to unlock everything from detergent to a single can of soda and never returned, is driving current and future warehousing demand.


Institutional investors aren’t blind to these trends. Warehouses are taking up a bigger and bigger part of global property funds. This month, Blackstone made a bid for a listed UK property investment trust offering landlord Industrials REIT (MLI) a 42% premium to take over its warehouse REIT in the UK.

Mark Reinikka, managing director for asset management at real estate investment firm BentallGreenOak, adds that there’s another pandemic-trend driving demand and that’s the need for nearshoring. Many companies fresh off pandemic induced supply chain woes are looking for space to bring storage onshore or at least on the same continent. “This is a fairly long-term shift that we’re going to see because you can’t just find space and write contracts overnight,” he says. “But what we’re seeing is a combination of storage and the need for warehouses that can support critical manufacturing.”


Curves ahead

The tightness in the market for warehouses could surprise some investors that have been burned by this sector before, says Stephen Dye, global analyst at Duff & Phelps Investment Management.


During previous periods of economic uncertainty, warehouses haven’t always performed as well. They were plagued by some of the same issues we now see in office space – over building and difficulty refinancing. There were some hints that a similar issue might arise for warehouses again, when Amazon started readjusting its contracts with warehouse landlords after overestimating its square footage needs. However, those issues were relatively limited and haven’t led to significant underperformance, Mr. Dye adds.


Mr. Dye says there is still the potential for refinancings to be difficult in the current rising rates environment, but it’s unlikely to be at the level of previous downturns in the sector. Financing new projects might still be difficult if they require a significant amount of debt, given the rising rates environment and tighter liquidity overall.


Warehouse developers are now facing a new problem, however. Some communities are pushing back against industrial sprawl and are limiting how many warehouses can be built and where. But Univest’s Lawrence says this could be a boon for investors that could see elevated rents as the result of higher competition for space.


Automation could also solve the problem of warehouses being pushed further out and away from denser urban and suburban areas. In recent years, large retailers have invested in automated fulfillment, which means they can run a warehouse with fewer human workers, making it easier to put warehouses in areas where the potential labor force is smaller.


“This is probably a net neutral for the sector,” Mr. Katz says. “Tenants are generally going to pay for these upgrades, but landlords might add-on some capabilities on their own if it proves to be valuble.”


Mr. Reinikka notes that developers may take a closer look at ways to add value to projects, because much of the existing warehouse stock in the US is old and in lieu of brand new buildings updates could be a net positive. “There is a demand for bigger truck bays, modern column spacing, automation, concrete floors,” he explains. “The obsolescence of the existing stock is becoming a negative factor.”


Warehouse developers also could make their bids for new space or redevelopments more attractive by incorporating solar panels into building construction. Mr. Lawrence notes that some states like New Jersey are pushing warehouses to install panels and sell their excess power back to the grid. “These are large buildings with flat roofs – it’s sort of a natural fit and could be a value-add down the line,” he says. “It also makes the buildings themselves more energy efficient.”


Even with these challenges, sources agree that warehouses are positioned to perform well over the long-term. “We’re going to see some new supply come online in 2023, which will eventually get absorbed. We should start to see vacancy decrease again in 2024, and perhaps a positive reacceleration in rent growth,” says Mr. Dye. “There is still strong demand coming to meet the 2023 supply wave, and with some developers pencils down on building, market fundamentals and rent growth within the sector will remain strong.”

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