This article is sponsored by Macquarie. It appeared in the Investing in Logistics and Distribution supplement with the February 2019 issue of PERE magazine.
Since starting to invest in logistics more than 15 years ago, the sector now represents about 30 percent of Macquarie Capital’s $38 billion portfolio on a global basis. Eric Wurtzebach, senior managing director at the firm, explains why Macquarie is bullish on the space, particularly US modern warehouses, on the heels of changing consumer behaviors, the continued rise of e-commerce and an aging millennial demographic.
PERE: Can you talk through some of the factors driving demand for US logistics?
Eric Wurtzebach: There are two main factors driving logistics/industrial space demand in the US. The first is the rapid increase in e-commerce as a percentage of total retail sales. In 2018, e-commerce was only 10.9 percent of total retail sales – but is projected to expand 15 percent per year going forward compared to the modest retail growth of just ~2 pecent.
The impact of the growth of consumers’ use of e-commerce on logistics demand and importantly of the requirement for next-day or same-day service has grown in the past several years and will continue.
“If investors go the development route, they need to find the right operating partner, a specialist with a deep knowledge of the space and that understands tenants’ demand”
E-commerce is dramatically increasing demand for logistics space. Part of this growth is due to the fact that e-commerce tenants generally require three times the amount of distribution space than that of traditional retail users because customers are seeking a greater variety of goods, and speed and delivery. As a result, for every additional $1 billion of retail sales, brick-and-mortar tenants require an additional 325,000 square feet of industrial space while e-commerce tenants require 1 million square feet. That’s the e-commerce impact. We project the US, just from an e-commerce growth perspective, will need an additional 33 million square feet per annum in the next few years.
The second important factor is changing demographics, especially the aging millennials. Millennials are the largest segment of the population and will comprise the majority of the workforce by 2025. The majority of millennials prefer to shop online versus in store and that’s a trend that appears to be accelerating. It’s driving the increase in e-commerce same-store growth that everyone is aware of. However, as millennials age they are coming into their prime-earning years. They have increased disposable income. We believe this will magnify the impact of e-commerce growth in future years.
PERE: How have those trends impacted the industrial real estate market recently?
EW: It has boosted industrial warehouse demand by 30 to 40 percent in 2017 as an example. As mentioned already, this is largely due to online sales requiring three times as much space because of the same-day and next-day imperatives in the market. These faster delivery times have also created a greater demand for infill sites. There’s a shortage in that space, and that forces developers to alter their development strategies to vertical. The availability rate for these products has dropped 7 percent. Asking rent has increased by 20 percent since 2014. All these trends are expected to continue regardless of the economic cycle.
PERE: In your view, what should a modern US logistics portfolio look like?
EW: It should be well located with access to key infrastructure and a deep labor pool. The buildings should have modern technical specifications. The portfolio should probably consist of logistics warehouses in central locations and, if possible, distribution centers close to key infrastructure. It’s important to be in a market that’s centrally located for regional distribution and access to infrastructure and transportation. As an example, Chicago is a great market. It’s the largest inland port in the country, can service 25 percent of the US population within a one-day truck drive and 40 percent of the US population in two days. From a location perspective, we also think there should be barriers to entry. Proximity to labor pool is also important. Tenants want to make sure it’s always front and center.
The second thing is clear height – the height of usable space and how much volume can be stored in a structure. Today, our US development platform, Logistics Property Company, is building 36- to 40-foot clear height because e-commerce tenants have more automation of the warehouses and are thinking of rent in terms of total volume of the building. It’s an important piece of the puzzle. As of 2017, only 19 percent of warehouses nationally were 32-foot clear height, but 40 percent of the total demand is for 32-foot clear height. A tremendous amount of existing logistics is becoming more inefficient and potentially obsolete as a result.
Bay depth and width is also critical. It gives tenants more space to accommodate and efficiently move goods. Additionally, we are finding car, trailer and truck parking is important. E-commerce puts more stress on the supply chain. E-commerce facilities also can be up to five times more labor-intensive than traditional distribution facilities. There tends to be larger car parking requirements for employees.
Lastly, proximity to an adequate labor pool is critical and often overlooked.
PERE: What do tenants look for from logistics space nowadays?
EW: From the tenant perspective, we’re in a very tight US labor pool. The first employee from a prospective tenant that comes for a site visit is human resources, not the real estate guy. If you can’t meet the high employment requirements, if your site can’t provide the proper local labor pool, there’s no point in the tenant being there, regardless of anything else. That’s a critical piece in looking at logistics today. Tenants will take an inferior location or building if they can get close to a good labor pool.
PERE: For institutional investors looking at US logistics, how should they approach the market?
EW: Given where we are in the cycle, it’s imperative that investors are selective in asset class allocation. Yields and cap rates are extremely tight in all asset classes. However, logistics looks very attractive over the long term. The e-commerce and demographic trends discussed may provide a logistics portfolio with advantages compared with other assets classes through cycles.
In terms of geographic locations, key markets are those with strong demographics and in-place infrastructure; Los Angeles / Inland Empire, San Francisco Bay Area, Chicago, Atlanta, Seattle, Northern New Jersey, Pennsylvania, Miami, Dallas and Houston. In terms of segment, right now we prefer developing industrial assets as opposed to buying core. Core asset pricing is very high. If investors go the development route, they need to find the right operating partner, a specialist with a deep knowledge of the space and that understands tenants’ demand.
Then you must make sure you get your alignment right with your partner. Because of significant institutional demand for quality assets, there is a lot of capital available. As a result, a lot of the deals that are getting done are very operator and developer-friendly. Investors should also be wary of the rise in construction costs, the impacts of recent tariff wars, and the shortage of labor.
Four essential features to minimize obsolescence risk
1. Good location
2. Clear height
3. Bay depth and width / Car, trailer and truck parking
PERE: What about last mile?
EW: Last-mile is definitely part of our logistics strategy. We believe the demand drivers and the logistics model supports growth in demand for large distribution centers and last-mile facilities. There’s probably too much focus on infill with little regard to functional obsolescence due to low clear height, truck court depth, etc. For us, it really depends on the specifics of the asset and on location. I am not a big fan of last-mile obsolete building acquisitions if the plan is to own the asset with a sub 28’ clear height. Macquarie Capital pays close attention to volume-based rent. If you can have a modern logistics facility in an infill area, that’s phenomenal.
PERE: How do you view the logistics space in Latin America?
EW: Latam is experiencing the same tailwinds in demand as the US. Brazil and Mexico have been our most recent focuses. The issues we manage in Latam are obviously a little bit different than in the US: the volatility of the political environment, the lack of regulatory environment, the lack of transparency, and educating institutional investors on those spaces. But Latam in general, and Brazil specifically, do offer an attractive entry point at this stage in the cycle. There’s ongoing economic recovery in those markets and improving credit markets, and we should expect that to support local consumption. Brazil is the largest e-commerce market in Latam and one of the fastest-growing e-commerce markets in the world. It’s also one of the most underserved logistics markets globally. You put all these pieces together and if you can manage the risk well, that is a compelling location and opportunity.