After 18 months of growth, the days of industrial real estate outperformance may be numbered. The sector, which has reached double-digit returns in recent months, faces threats from potential regulation and overvaluation, according to a UBS research report released this week.
“Overall we think that the stronger returns from industrial will continue through the remainder of the year and into 2019, but that in the medium term the strong outperformance will eventually come to an end,” UBS wrote.
Over the last 18 months, US industrial reported a 13 percent return according to NCREIF data, while UK industrial returned 20 percent according to MSCI. At the same time, investment in the sector rose 39 percent globally in 2017. In comparison, investment in office increased 5 percent and retail investment decreased 9 percent.
However, that surge in growth in the industrial sector presents an overvaluation risk if underlying fundamentals fail to keep up, UBS reported.
In addition, potential regulation could pose a threat to future rent flows in the industrial real estate sector. Traditional retailers have already called for a “parcel tax” that could weigh on online businesses and weaken demand for logistics facilities used for delivery, the report noted. The rise in cost may force e-commerce companies to cut back on distribution center space, and the resulting decline in demand can drag down rent prices. In March, the Australian government proposed a $5 flat tax on overseas parcels worth less than $1,000, leading eBay to voice its concern. “The sector could be a victim of its own success,” UBS said in its report.
Additionally, the movement of vehicles transporting goods destined for logistics facilities could be restricted in an effort to address environmental or traffic congestion concerns, which consequently could make last-mile logistics centers less viable. London’s air pollution spike, which briefly surpassed Beijing levels in January 2017, led mayor Sadiq Khan to push forward with a vision of an Ultra-Low Emission Zone. Heavy goods vehicles in particular have been targeted by new regulation aimed at reducing emissions in the city.
Logistics facilities used to help e-commerce businesses with distribution can be built quickly and consequently are at risk of oversupply. However, UBS did not expect industrial supply to hold back rents. In fact, supply may be catching up with demand in many markets, with urban logistics facilities now competing with many other property types such as residential for land.
As industrial sector growth wanes, UBS analysts Paul Guest and Sean Rymell expect markets to break away from “this single outperformance sector picture.” Industrial, which has gained prominence in almost every region around the world, may continue to be an outperformer for a few more years but sector performance will likely go back to differing from region to region, depending more heavily on local supply and demand relationships, they said.