Industrial N Illinois

Industrial sentiment stays strong as we sail into 2020

Industrial sentiment stays strong as we sail into 2020,ph1

There are strong headwinds that may turn the bull real estate market bear, such as a decelerating economy and a simmering trade war. But a new sentiment survey suggests that the industrial sector is riding a separate current that should propel it beyond any slowdown in the overall market.

A booming e-commerce segment, strong market fundamentals and capital market optimism all factored in the survey results, conducted by Real Capital Markets (RCM), a part of LightBox, and The Society of Industrial and Office Realtors (SIOR). Taken as a whole, the respondents advocated continued investor focus on the U.S. industrial sector heading into 2020, with Chicago as one of the nation’s markets to watch.

For market fundamentals, there is unlikely to be any slackening in e-commerce growth, vacancy rates remain tight, rents continue to rise and the sector has witnessed record absorption rates. On the capital markets side, allocations are increasing, there is plenty of capital waiting to be deployed and optimism reigns that cap rates could compress further.

More traditional industrial users such as manufacturing and packaging firms are doing well, but the behemoth in the marketplace is the logistics and fulfillment space required by the meteoric rise in online shopping. As disruptive as it has already been, e-commerce only accounts for between 7 and 26 percent of all retail sales, depending on which source you cite (though most skew toward the single-digit side). With so much room to grow, the sector is projected to grow by 10 percent per year—which will have continued transformative influence over the industrial sector.

“No one could have predicted the impact that e-commerce would bring to the supply chain, our industry and the global economy,” said JoJo Yap, chief investment officer of Chicago-based First Industrial Realty Trust, Inc. “I am often asked when will the music stop. I don’t know, and I don’t think anyone does. No one really knows the maximum potential of e-commerce.”

Among the key findings of the 2019 RCM-SIOR Industrial Sentiment Report, land-constrained markets should continue to experience rent growth, giving an advantage to existing property owners. Nationally, investors will likely target the Inland Empire, Northern New Jersey and Miami. In Chicago, institutional investors have driven land prices in the O’Hare submarket up to more than $30 per square foot. According to Erik Foster, principal and leader of Avison Young’s national industrial capital markets group based in Chicago, core investment property near O’Hare has, in some instances, reached around $125 per square foot.

The survey respondents also believe that, broadly speaking, industrial development is strong and not in danger of overbuilding. “In most markets across the country, we are seeing an appropriate level of development activity,” Yap said. “With fundamentals where they are, I expect the market will continue to add supply and that the steady pace of demand we’re seeing will fill those spaces. We don’t want to invest in markets where we believe there is the possibility that the addition of supply will outpace demand.”

There is a particular focus on last mile delivery by developers, as distributors desiring locations as close as possible to the end users have accelerated demand for space in urban locations. Chicago-based Hilco Redevelopment Partners, for example, is developing the 1-million-square-foot Exchange 55 in Chicago’s Little Village neighborhood, scheduled for completion early next year.

“There is a significant push to tap into consumers in large, urban population pools, which is driving considerable warehouse and distribution activity,” said Tina Lichens, RCM’s chief operating officer.

That said, investors are keeping an eye on the supply of U.S. industrial space, which has witnessed exceptional new construction over the past seven years. In this year’s report, more than half of the survey respondents noted being somewhat concerned about overbuilding, compared with a third saying they were not concerned at all.

Nearly 32 percent of participants in the RCM-SIOR report expect cap rates to compress further over the next 12 to 18 months. Since 2015, national average cap rates have compressed from 6.8 percent to a current level of 6.3 percent, according to data from Real Capital Analytics (RCA). Those rates are down to 4 percent to 5 percent in key markets, however, according to report participants.

Even as e-commerce drives development, it also impacts investment activity. Respondents overwhelmingly cited the phenomenon as the top growth factor. Meanwhile, 24 percent of the survey respondents noted the amount of capital waiting to be placed in the market.

A quarter of respondents said industrial pricing will increase by 5 percent or more over the next 12 to 18 months. That’s down from 38 percent in 2018 and 34 percent in 2017. In the 2019 survey, 35 percent said pricing will increase by less than 5 percent, while 34 percent said pricing will stay the same.