What is Driving the Demand for Industrial Real Estate Assets?
By: Liam Lewis
As we end the first quarter of 2021, the commercial real estate investing landscape is experiencing many changes. Entering the second quarter, everyone wants to know which asset classes will see quick recovery and which will continue to struggle in the post-Covid world. In the past 12 months, the pandemic has reshaped many industries. These shifts have demanded that investors adjust and have also expanded our ability to understand how external factors dramatically impact tenant and investor demand. In 2020 and into 2021, retail and office assets have faced challenges that no one ever predicted. These unprecedented circumstances have forced us to quickly adapt and underwrite assets in different ways to meet both tenant and investor needs driving creativity and innovation in the process. The pandemic has impacted economies around the world, tenant needs have shifted, and in turn, capital supply has changed as well.
Given the covid challenges that office and retail are facing, many investors are reassessing portfolio distribution. Thanks to the e-commerce boom spawned by the pandemic, industrial assets are offering a more conservative investment opportunity, whether it be core+ acquisitions with credit tenants or ground-up build-to-suit construction. Investors are not the only ones adjusting and capitalizing on these shifts in the industrial space. Institutional capital is becoming more and more readily available especially in terms of industrial development and acquisitions. Not only is the institutional space growing, but private capital is coming in with increased flexibility. Some of the creative options that we have seen in the first quarter and expect to see even more moving forward include the use of senior stretch loans, mezzanine debt, preferred equity, and sale-leasebacks to fill the gaps left by institutional money. In terms of capital availability, investors and lenders are holding a significant amount of dry powder, especially compared to where we were a year ago today. Industrial assets are shifting from the least favorite food group to being highly sought after by investors, lenders, and tenants.
To determine the sustainability of this spike in demand we must explore the driving factors. E-Commerce is defined as any purchase or sale of a good or service through an online platform. In retail e-commerce (of physical goods), yearly total revenue increased by $71.55B in 2020 and is projected to increase by another $131.74B by year-end 2025 (Statista). This exponential growth is a great indicator of what’s to come in terms of industrial space demand. Before 2020 yearly growth averaged only $37.09B per year. To put this into perspective, e-commerce retail revenue grew 120% in 2020 even as the Covid pandemic put the brakes on the overall economy. The revenue growth rate is expected to continue this pattern and we will likely see yearly growth breach 100% yearly through 2025. In the fast-paced world of e-commerce, logistics and distribution are central concerns that are driving a focus in purchasing on increasing efficiency and reducing logistics-related expenses. With this dramatic change we have seen as a result of Covid and technological advancement, it’s only fair to ask, how is this impacting industrial space needs?
With this dramatic increase in demand and the expectations of its continued growth, industrial asset needs will continue to skyrocket. As more and more products are purchased online, these retailers are facing scale challenges that in most cases have to do with manufacturing and warehouse capacity. With 1 and 2-day delivery becoming increasingly popular, and soon to be a must, companies have to rethink the way each product is getting from the manufacturer to its final destination. A key term to understand here is “last-mile” delivery/distribution. The “last-mile” is the final step in the transportation and delivery process. This is defined as the period in which the product leaves the last checkpoint and arrives at the final destination. This “last-mile” is the most expensive (about 50% of supply chain costs) and time-consuming part of the shipping process. In the wake of such dramatic demand growth, companies are doing anything possible to cut logistics-related costs. A trend that we are seeing, as a result, is an increase in the number of industrial warehouses that companies are leasing, building, or acquiring. Real estate expenses currently only reflect 3-5% of supply chain costs, providing a perfect opportunity to reduce expenses. In order to reduce the expenses involved with “last-mile” delivery, you must increase the number of hubs you own, which in turn reduces transport distances. With increased demand also comes increased inventory levels, impacting space needs significantly and pushing firms to buy, lease or build bigger warehouses. In 2020 there was a record 680 million square feet (MSF) of new industrial space leased in the Americas alone (Area Development). A logistical transition is upon us that presents ample opportunity when it comes to lending on or investing in industrial assets.
Product demand has seen significant growth in the last few years, and the Covid-19 pandemic has accelerated it. The increasing demand for products sold online and quick delivery is directly impacting suppliers, manufacturing levels, and of course demand for industrial assets. A key contributing factor to demand for industrial space is the quick recovery seen in US manufacturing. Chris Williamson, the chief business economist at IHS Markit reported that “the US manufacturing sector is close to fully recovering the output lost to the pandemic last year.” Manufacturing levels have reached a 3-year high, and the exponential demand we are witnessing is pushing suppliers to their limits.
The combination of the intense demand growth seen in the last year, and 1-to-2-day delivery norms is recreating the increased need for industrial space. With these shifts in the market, capital must also adapt and realign itself with the changing times. Reflecting on conversations with many capital groups at the 2021 MBA conference, as well as several current clients, we are very aware of the dry powder available, and what it’s looking for moving forward. Here at Lever Capital Partners, we understand that when trends like this present themselves, the capital is not far behind. Whether your needs include debt, joint venture equity, or secondary financing, we are confident that we can assist you along the way, while emphasizing efficiency and transparency.