2-Day Shipping: Investing in Industrial Real Estate in an E-Commerce World
The faster pace of growth in e-commerce in recent years might be attributed to Amazon’s influence. Many traditionally brick-and-mortar retailers have shifted more of their business focus online as a way to stay competitive with the internet sales giant.
This trend has meant continuing performance gains for industrial real estate.
Source: St. Louis Federal Reserve Bank
From a real estate perspective, the rise in e-commerce has increased demand for distribution centers and warehouses.
This has led to low vacancy rates – the percentage of all existing properties that are unoccupied – and higher rent for industrial properties.
Those conditions have driven strong returns, and with that, capital market interest for industrial assets.
Why is It Difficult for Investors to Access Industrial Real Estate?
Compared to apartment, retail and office real estate, industrial assets have always been difficult for institutional investors to gain meaningful exposure.
Warehouses have a lower rent per square foot relative to other property types and only massive facilities tend to garner the interest of multi-billion-dollar core real estate funds.
Those assets are hard to come by and have commanded a premium due to the higher demand.
The NCREIF-ODCE is a benchmark made up of 24 core real estate funds. As of June 30, 2018, industrial assets only made up 16.6% of the allocation of the NCREIF-ODCE.
This is an increase from three years ago when industrial assets made up only 13.7% of that index. Even with all the tailwinds and strong performance of industrial assets, there has only been a minimal increase in allocation by institutional investors.
Despite difficulties accessing the sector, some core managers have strong networks in the space that provide off-market opportunities.
Why Is Industrial Real Estate a Worthy Component of a Diversified Real Estate Portfolio?
While the growth in e-commerce has been the main driver, new regulations limiting truck drivers’ hours and the deepening of ports have also increased demand for warehouses and industrial properties.
The million-dollar question is whether these trends will persist and continue to drive outperformance in this subsector.
The NCREIF NPI index, which provides data by underlying property type, shows that industrial properties have generated strong performance relative to other property types.
Warehouse overbuilding tends to occur during times of economic growth because warehouses are relatively easy to construct, with an average U.S build time of 2.7 months according to the World Bank.
For comparison, a 20+ unit apartment complex requires an average of 14.9 months to be completed according to the Census Bureau. New supply tends to deter future rent growth, increase vacancy, and slow down strong returns.
Demand for industrial space tends to be cyclical as its performance correlates to GDP growth.
This means that industrial real estate performance can trend along with stages of the economic cycle.
In a recession, when companies downsize their footprint, occupancy decreases and could reduce investor income. Coming out of a recession, companies are hesitant to expand, and this leads to a slow recovery for industrial properties.
An investor would ideally want to hold these assets through a downturn and not have to be a forced seller.
Investors would do well to consider industrial properties as part of a diversified real estate portfolio.
Though an economic downturn may at some point slow industrial real estate’s performance, industrial properties have been the top-performing property type since inception of the NCREIF NPI and tailwinds continue to support this sector as the preferred real estate of the 2-day shipping economy.