The logistics sector has enjoyed 37 consecutive quarters of positive net absorption, and a sixth consecutive year of over 220 million square feet of net absorption. Total net absorption lagged new deliveries at year-end 2019, with vacancy rates rising slightly to 5.1 percent. This is not a sign of weakening market conditions, but can be attributed to the lack of quality vacant space left in the market to absorb, which has also resulted in a decline in the average size of lease transactions.
This performance has not gone unnoticed by investors. The total volume for transactions over $5 million surged past $100 billion in 2019 for the first time. Additionally, a ‘new normal’ in terms of liquidity has been emerging since 2013, as sector volume growth has averaged 22.5 percent year-over-year, with volumes in 2019 nearly doubling the 10-year sector average of $54 billion.
According to NCREIF, industrial’s annualized returns from 2000 to Q3 2019 were 10.3 percent – 20.5 percent and 13.4 percent higher than the office and multi-housing sectors respectively. Return growth is primarily driven by the strength of e-commerce and leasing fundamentals, which are driving aggressive rent growth and attractive cash returns. The healthy return rate has not come at the expense of stability as the implicit risk of industrial remains lower than the other major property sectors, indicating the ongoing attractiveness of industrial investments. The sector has also experienced record-setting cap rate compression while maintaining the widest risk premium among the other property sectors.
Foundational shift due to e-commerce
As retailers realign supply chains and distribution networks to accommodate the growth of direct-to-consumer e-commerce operations, new opportunities for industrial investment are emerging. Traditional retailers realize the need to create distinct supply chain networks to support this expanding business area, and thus, created a new demand base for the sector. This is important when it comes to newly developed big-box space and urban infill space close to dense populations of consumers. E-commerce growth as a percentage of overall retail sales – 5.8 percent in 2013 to 11.2 percent in November 2019, according to the Bureau of Labor Statistics – has driven demand for industrial space and is correlated to rising rents and falling vacancy.
And newly announced expansions of e-commerce operations by grocery retailers seem primed to escalate in the next three years as they roll out free service offerings. Grocery retail is one of the final frontiers when it comes to the evolution and retooling of traditional retail store fulfillment supply-chain networks. E-commerce orders account for just 3 percent of all grocery retail sales in the US. Preventing expansion is the required capital expenditure on climate-controlled industrial space. Grocery delivery operations have been constrained to large volume, traditional hub-and-spoke models of fulfillment to physical retail stores.
If traditional retail trends are any indication as to how rapidly investment and supply-chain realignment will occur, this segment of industrial demand may continue to transform in a similar fashion as traditional retail supply chain networks. Several grocery retailers have invested in pilot programs for advanced picking facilities and selective market tests throughout the country, with plans for expanding the number of markets upon testing. In an increasingly competitive investor landscape, expanding investment strategies to align with the foundational shifts that must occur to support the expansion of grocery retail into e-commerce operations are expected to be an area of focus for investors comfortable with the high capital expenditure and unproven risk associated with these types of facilities.