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Industrial Emerges from Pandemic in Relatively Good Health

September 23, 2020

But nearly six months into the crisis, it appears that the sector has been more resilient than others.

The pandemic was a significant topic during NAIOP’s I.CON Virtual 2020, which was held online in June.

“I don’t think we’re immune to what’s happened, but we’ve held up well,” said David Fazekas, a senior managing director with the Black Creek Group, during a panel discussion at the event.
 
An explosion in e-commerce activity at the height of the pandemic, when much of the country was under stay-at-home orders, is a major factor behind the industrial sector’s stability. According to payments processer ACI Worldwide, global e-commerce sales rose 28% in June 2020 compared to June 2019. That was the largest year-over-year increase in sales since COVID-19 restrictions were put in place in March.

“Accelerated adoption of e-commerce was definitely a positive trend of the pandemic,” said Michael Coppola, a partner with Bluewater Property Group. “E-commerce has changed our industry. We’ll all be attuned to how much of that sticks.”

Although JLL expects that online sales will decline from a recent peak of 26% of all sales, they will likely remain in the low 20s for the near future. This should lead to continued demand for last-mile facilities.

“Is e-commerce going to save us all?” JLL President of Industrial Brokerage Craig Meyer asked rhetorically during another panel at I.CON Virtual 2020. “For the time being, probably yes.”
According to Barbara Perrier, vice chairman with CBRE, COVID-19 accelerated the e-commerce trend by five years.

“Everybody talks about Amazon, but companies like Walmart, Target and Costco have really gained market share during this period,” she said.

Jeremy Giles, global head of customer-led solutions for Prologis, said the current crisis has led to growth not only in total online sales volume, but also in the number of e-commerce customers, and that related demand growth will likely be sticky. Along those lines, panelists noted that demand for industrial space held up well during the crisis, and e-commerce giant Amazon is a significant reason for that. The company added 175,000 employees at a time when more than 30 million Americans were out of work.

“The space that is coming online is getting gobbled up by Amazon,” Coppola said. “That’s certainly going to help rent growth.”

Amazon has taken at least 25 million square feet of space so far in 2020, and that doesn’t include what the company has in escrow. Third-party logistics providers and logistics companies are also taking vast swaths of inventory, as well as spaces suited for the reshoring of manufacturers.

Coppola said that his company, which is focused on the Northeast, looks to continue investing in that region.

“These Tier 1 infill markets are insulated from long-term trends that COVID-19 is not going to change,” he said. “COVID has only accelerated a lot of those trends. We don’t see anything in the way of distress, unless it’s a one-off like a retailer or someone with liquidity needs. We’re in a bit of a wait-and-see period. Buyers are being appropriately cautious right now.”

Fazekas said values have held up really well in industrial space, despite a lack of data points because of closures related to the pandemic.

“We were really worried about how we were going to get surveys and titles recorded with courthouses closed,” he said. “We had a few hiccups along the way, but we were able to navigate that. Inspection and permitting were delayed, but most municipalities quickly moved to virtual, which was surprising.”

Other panelists echoed that sentiment.

“We were impressed with municipalities that really adapted better than we thought they would, whether with Zoom or teleconference meetings,” Coppola said.

The panelists all agreed that lenders are more cautious in the current climate.

“They’re still in a bit of triage mode trying to figure out their mandates going forward,” Coppola said. “Caution is definitely the word in the lending market now. If you get a loan, it’ll probably have some kind of recourse tied to it. That’s why relationships are more important than ever.”

Fazekas agreed.

“Spreads have widened,” he said. “Leverage levels have increased. We’ve gotten more requests for recourse.”

Prior to the pandemic, both the economy and the market for industrial properties were strong.

“Going into late February, it was as robust a capital markets environment as I’ve ever seen,” said Nicholas Pell of Link Industrial Properties. “There was a deep buyer pool and a scope of assets for buyers to pursue. Then COVID hit, and everything sort of stopped overnight.”

Perrier concurred.

“At the beginning of 2020, we all thought it would be a banner year,” she said. “Then it all halted, and the only thing moving was single-tenant, long-term deals in core markets.”

Fortunately, the pause was short and far less damaging than initially projected.

“The East Coast and West Coast have snapped back quickly, and the center of the country is getting there, but just not quite as fast,” said James Clewlow of CenterPoint Properties. “Leasing was off some, but a lot depended on the market and what level of shutdown was happening there. For example, Houston was very strong all the way through, and so was Florida.”
CBRE is seeing positive leasing activity too, said Perrier, and broker sentiment is high.

“The winners are those with great locations,” said Clewlow. “The ‘location, location, location’ adage is very applicable to industrial today. Companies like Amazon and Wayfair want to be near their customers, and the issue is what kind of building works for them. Does it have to be new? Not always.”

The demand for these prime spaces is reflected in rents. There are rent spikes for the best locations and challenges for the worst.

“A building may be functional by all standards but not in the right location, and those are the ones slower to lease,” Clewlow said.

Traditional multitenant industrial business parks are also still emerging from COVID’s impact.

“A lot of those deals were shelved because of uncertainty on the rent roll,” said Perrier. “Disruptions were short term, and collections have been strong at 90%-95%. We expect to start seeing multitenant parks coming back online soon, with very active third and fourth quarters.”

Investors are still eager for deals. Pell said Link has actively pursued deals too, closing $1.9 billion in acquisitions and selling $900 million in dispositions this year.

There’s a lot of capital chasing infill markets, especially if pricing is right, noted Perrier, referencing large site sales that CBRE just completed near both Los Angeles International Airport and Hawaii’s Port of Oahu.

“A lot of lenders want to get into industrial space, and it’s a good opportunity now because it’s a safe haven,” she said.

With regards to deal flow between Tier 1 and Tier 2 markets, Perrier said she believes Tier 1 has returned to pre-COVID pricing, but there is differential in Tier 2.

“My sense is that the definition of what’s Tier 1 and Tier 2 is changing,” she said. “It’s going to be tied more to where population is, because of e-commerce.”

Perrier also predicts a shift in retail conversions to industrial space to accommodate the last mile, which will necessitate conversations with cities and municipalities that will see fewer sales tax dollars but will benefit more from occupied spaces rather than vacant ones.

While multimillion-dollar projects in prime industrial markets may make headlines, 85% of industrial transactions come in under $20 million and are taking place in secondary and tertiary markets throughout the U.S. A session at I.CON Virtual 2020 focused on the investment dynamics of this vast, active and diverse sector within the industrial market.

The industrial market benefits from the massive growth trajectory of e-commerce, as online sales growth outpaces traditional retail sales. With brick-and-mortar stores closed due to the pandemic, it’s hardly surprising that this trend has accelerated — and the rate of growth is astounding.

“It’s a trend that’s already in place but it’s a COVID-accelerated trend,” said Al Pontius, senior vice president and national director, office and industrial, healthcare and special assets with Marcus & Millichap.
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