The industrial markets in the US are finally coming into their own and investors are seeking to capitalise. Barbra Murray reports
As the US commercial property markets slowly emerged from the post-crisis downturn, the multi-family sector in the US quickly became the darling of investors. The logistics market still finds itself in the shadows of rental apartments, but it has come back to life recently. Demand is high, with numbers peaking in many markets. Development activity is being kept in check, and the investment community is taking note.
“The [logistics] sector got hit very hard by the recession, but there’s been a tremendous amount of demand and virtually no supply for the last five years, so the market has come back,” says Bill Maher, director of North American investment strategy for LaSalle Investment Management.
The statistics tell the story of a revitalised sector. At mid-year, the national vacancy rate was 7.4%, below the prior cyclical low of 7.5% in 2008, according to a report by commercial real estate services firm JLL. It has been a good year and JLL expects the vacancy rate to fall closer to 7% by the end of the year.
Longevity and consistency have become defining characteristics of the sector, which has now experienced 17 consecutive quarters of recovery. The simple fact of the matter is that demand for class-A logistics space is steadily outpacing supply.
According to JLL, Los Angeles, the third-largest logistics market, closed the second quarter with the lowest vacancy rate of just 4%, followed by Denver at 4.1%, Long Island, New York at 4.5%, and Salt Lake City, Utah at 4.8%.
The success of the logistics sector can be attributed to two major factors: the economy and the increasingly powerful e-commerce market. Positive growth has been the norm of late for the economy in the US, where the real GDP rose at an annual rate of 4.6% in the second quarter, according to the US Department of Commerce.
In Denver, for example, consistent demand from energy and business services companies is the driving force between the rising need for logistics space. Businesses are finally feeling comfortable enough to relocate to bigger or better facilities. In August, Yokohama Tire Corporation announced it would relocate its Western Region Distribution Center from a 380,000sqft warehouse to a 658,000sqft one in Chino, California, part of the high-demand Inland Empire market, approximately 35 miles east of Los Angeles. In October, Swedish furniture chain IKEA committed to a nearly 850,000sqft warehouse in suburban Chicago.
The growing focus of retailers on internet outlets away from traditional brick-and-mortar shopping outlets is having a direct impact on logistcs. As noted in a CBRE report: “In order to keep up with growing demand, online-only and omni-channel retailers – companies that blend in-store, online and mobile channels to create a seamless consumer experience – are making large-scale investments in their supply chain. This is stimulating demand for the limited supply of high-quality industrial properties nationwide, especially in key port markets and high-density population hubs.” The need is only going to grow stronger; by 2017, CBRE notes, online sales could account for more than 10% of all US retail sales.
There is one company gobbling up space across the country: Amazon. The international online retailer has practically single-handedly changed the look of the logistics sector. Recent transactions include the leasing of the 575,000sqft Cherry Logistics Center in California’s Silicon Valley in a transaction that marked one of the largest warehouse leases ever in Silicon Valley. The company’s need for state-of-the-art logistics space appears to be nearing the insatiable, thus its flurry of build-to-suit facilities.
“The e-tailing business has been the biggest consumption of existing buildings originally and now it is on the build-to-suit side,” says John Huguenard, head of industrial capital markets with JLL. “Amazon certainly has been the biggest of the big.” Amazon has opened 27 new fulfilment centres since 2011, and eight of them delivered in 2013 with a total of 7.7m sqft.
However, the world does not revolve around Amazon; nor does the logistics sector.
“Because a lot of major corporations in the US – like Walmart, Target and food and beverage-related companies – have held off and not done build-to-suits, we’re seeing a lot of build-to-suit activity,” Huguenard notes. Developers seeing the demand for big-box space have responded with an increase in developments, and the majority of those gargantuan facilities are build-to-suits.
The pursuit by e-commerce businesses and other big-box retail users of more distribution centres and warehouses also indirectly affects the logistics sector, as their need spurs a similar need among transportation services such as UPS and FedEx. In September, the federal government got involved in a proposed FedEx facility, with Senator Charles Schumer convincing the US Army Corps of Engineers to expedite an environmental review that would allow for construction of a proposed FedEx facility in Hamburg, New York, a suburb of Buffalo, which is located approximately 100 miles from Toronto, Ontario.
While the e-commerce businesses may be leading the way in big-box activity, they, along with smaller businesses, are also sparking new demand for smaller facilities. “Amazon has been a traditional user of big-box or large distribution centres usually over 500,000sqft, but in the last year or two they’ve been making a big push into urban areas as they start to ramp up and offer same-day delivery so they need to have a couple of smaller warehouses within 10-20 miles of the city centre,” Maher says. “Now you’re seeing medium-size distribution tenants and even small local distribution companies starting to rebound and take more space in the market. That’s a good sign.”
Whether it involves sprawling facilities or small warehouses, major cities or tertiary locations, the logistics sector has regained its lustre, to the point where developers now feel comfortable building properties without anchor-tenant leases in place. According to JLL, 60% of construction activity in the market consists of speculative development.
All signs point to the logistics sector continuing to be successful. John DiCola, partner with KTR Capital Partners, says: “The recovery now feels a lot more broad-based and not limited to any one particular drive, but is a reflection of a continued recovery that’s now resulting in diminished blocks of space and that are balanced between supply and demand that is, overall, strengthening operating fundamentals throughout.”
Competition heats up
Good statistics and investor interest go hand in hand. “One to two years ago it was the low cost of capital that lured investors, but today it’s the appealing fundamentals that have investors competing in both acquisitions and development,” says Huguenard. “We’re continuing to see bidding wars.”
Again, the numbers tell the story. “In line with the decline of private equity-backed buyout deal activity as a whole following the onset of the financial crisis in 2008, investment in logistics-focused US-based portfolio companies has shown some glimmers of recovery since 2012,” says Chris Elvin, heads of the private equity division of data and research firm Preqin. “As of mid-year 2014, aggregate deal value has reached $2.6bn (€2bn), marking the highest level seen since the record level of $4.6bn recorded in 2007.”
This year, portfolios trades have accounted for a large portion of sales in the logistics market. Huguenard says: “What’s going on in the US from an investment perspective, what’s driving a lot of the trades is the cost of money, both equity and debt. So, you’re seeing a lot more Wall Street-type firms and global companies – a lot of people on the aggregator side of the business – buying larger portfolios.”
International industrial developer Prologis and Norges Bank Investment Management, manager of the Norwegian Government Pension Fund Global, recently closed their joint venture, which acquired 12.8m sqft US logistics portfolio formerly owned by Prologis for $1bn. Prologis also completed the sale of a national group of properties totalling 7m sqft to TPG for $375m. During the second quarter, NorthStar Realty Finance signed on to invest $167m of preferred and common equity for a 50% stake in a $406m, 6.3m sqft group of assets spanning 17 states. And the list goes on.
“The competitive landscape is most competitive for well-leased, core class-A assets,” DiCola says. “Most investors are still very competitively pricing in cash flow, so well-stabilised, high-quality buildings are still most in demand. But the difference now is, rather than just being focused on demand in primary markets, you’re seeing the spread between primary and secondary markets starting to narrow.”
Still, geographically there are the red-hot markets. Southern California’s Inland Empire, Huguenard says, is a favourite right now because “that’s where the best-of-the-best product is,” and the cap rates, which are in the low-to-mid 4% range, serve as an indicator of the market’s popularity. “[Cap rates are] very, very low and nobody really wants to sell because, where are they going to replenish that existing product?”
In general, the coastal areas are at the top of investor preferences. Denver-based real estate developer and manager DCT Industrial Trust is focusing more on the coastal markets – locations such as Seattle and Southern California on the West Coast, and Miami, New Jersey and Pennsylvania on the East Coast – where there is higher growth in already healthy rents. DCT Industrial Trust is shining a brighter light on the coastal areas in its transactions.”
Assets in coastal markets accounted for approximately half of DCT Industrial Trust’s annualised base rent at mid-year. “And that’s a trend; it’s a number that’s improved over the last several years, meaningfully over the last several years and given our investment focus, is likely to continue to improve,” Matthew Murphy, CFO of DCT, said during the company’s second quarter earnings call in August. Duke Realty also continues to redeploy money to coastal markets.
Naturally, the success of the US logistics market is attracting attention from investors beyond US borders, and Canada is one of those investors leading the charge. Canadian institutions have invested more than $20bn in the market over the past decade, according to JLL, accounting for nearly one third of all foreign real estate investment in the US. At the end of Q3 this year, Canadian investors had spent approximately $561m on US logistics assets, according Real Capital Analytics.
Big Canadian names have been expanding in the sector. Toronto-headquartered Brookfield Property Group acquired Industrial Developments International, an Atlanta, Georgia-based owner of US distribution facilities in 2013 for $1.1bn. In May of this year, Brookfield combined the company with EZW Gazeley, a leading developer of European logistics assets properties that the firm also purchased in 2013, to form IDI Gazeley for the express purpose of acquiring high-quality warehouse and distribution facilities in major markets across the US, as well as Canada and Europe.
More recently, Canada Pension Plan Investment Board announced that it had injected an additional $500m into its Goodman North American Partnership, an $890m joint venture launched with the Goodman Group in 2012 that marked CPPIB’s first direct investment in US logistics.
While it is evident that Canada is keeping US logistics on its radar, the country’s interest in the sector has been surpassed recently. “There’s Middle Eastern money continuing to chase yield,” says Huguenard. Year-to-date, buyers from the United Arab Emirates (UEA) have invested $725m, according to Real Capital Analytics. And Bahrain’s purchases amounted to $195m by the end of Q3.
What can be expected in the US logistics in the future is more of the same – the continuation of desirable conditions that serve as a powerful magnet for investors.
“We don’t yet see signs of there being oversupply of product,” says DiCola. “Right now, national delivery of new investor product is still low by historic standards, so demand is still outstripping supply and we expect that to continue for the next 18 to 24 months. You’ve always got to be cautious, but today we see a good overall healthy environment within the industrial sector.”