The Industrial Gold Rush Will Provide Opportunity For Some, Disappointment For Others
Online shopping has experienced an unprecedented boom over the past year, thanks to the necessity of social distancing. Soaring demand has prompted e-commerce retailers and third-party logistics companies to make aggressive real estate plays in every major U.S. market.
Reminiscent of a gold rush, real estate players who previously had limited or no experience in the product are jumping at the chance to get in on industrial’s remarkable growth trajectory. Those with credibility and resources are likely to prosper, but not everybody will be able to successfully pivot into a sector that is brimming with competition.
“I think everybody is interested in buying more industrial. But I don't think everybody is set up to do it,” Capital One Senior Vice President Sadhvi Subramanian said.
It’s no surprise that industrial’s healthy outlook is attracting new entrants from all over the spectrum. New industrial completions in the U.S. are forecast to increase by 29% in 2021, while net absorption is projected to reach nearly 250M SF, well above the previous five-year annual average of 211M SF, according to CBRE’s U.S. 2021 real estate outlook report. Strong pre-leasing of speculative projects and rising rents are all contributing to the narrative that industrial is the safest place to put money right now.
Whether it’s first-time clients looking to enter the space or existing clients wanting to expand their portfolios, architecture firms are seeing a spike in inquiries for industrial projects. That demand has become so significant that Gensler is considering creating an industrial practice group for the first time.
Gensler Studio Director, Energy Leader and principal John Haba said that for more than 10 years, the firm has mostly worked on high-value, build-to-suit, technology-heavy industrial projects for clients. Many of those projects have fallen within their critical facilities practice, including data centers and control rooms.
Since the onset of the coronavirus pandemic, Gensler has started to talk to developers about speculative industrial projects that incorporate more flexibility and advanced technology solutions than a typical “dumb box.” That kind of project could be adapted to meet the needs of a wide variety of future tenants, offering more value in the long run and filling a gap in the market.
Another area of industrial that the firm has seen major interest in is cold storage, particularly for niche products and specialty foods. Those facilities may be smaller in scale but cater to an area of the distribution market that hasn’t been well-served before. That attention to lacking areas of the market is where Gensler aims to bring additional value.
“If you're just doing dumb boxes, it's relatively easy, and anybody can come in there and they just have to figure out a cheaper way to do a dumb box. That's pretty thin value,” Haba said.
The expansion in industrial also balances out Gensler’s slowing book of business in office design. As demand for industrial work has taken off, requests for office projects have slowed, according to Gensler co-Managing Director and principal Stephanie Burritt.
“We're certainly getting less demand for office buildings at the moment, just because I think the market, the world is trying to figure out what is the long-term need going to look like,” Burritt said. “A lot of people have pressed the pause button on some of those projects that are specifically around office development.”
Gensler is still determining what its future industrial practice could look like. Haba expects within the next 12 months, there will be more clarity around where the best opportunities for Gensler are based on gaps in the market that have been exposed by the pandemic.
“I think we'll see where we're going within six months, maybe a year, to really see how this stuff solidifies,” Haba said. “How we market [an industrial practice] will be a result of more clarity around where the opportunities, where the voids are in those networks that will need to be filled.”
Top-tier architecture firms like Gensler are well-equipped to expand their industrial offerings and do well, but that may not be the case for smaller, inexperienced firms wanting to capitalize on the surging demand.
Powers Brown Architecture principal Nazir Khalfe, who specializes in industrial design, said there are more architecture firms taking on industrial projects right now because typical sources of income have slowed. In particular, the firms that usually do public work projects like schools are more likely to return to that work after the economic disruption of the pandemic has passed.
“I think it's come to fruition now because of COVID, because the money's stopped. But I think this industrial boom has been going on for the last three, four years. And I think coming in now, you're pretty much on the tail end of it,” Khalfe said.
Powers Brown has extensive experience in designing industrial products on a national scale, and Khalfe said that most clients are aware that some architecture firms have more credibility in the space. For that reason, inexperienced firms entering the space now may not receive the volume of work they are hoping for.
“I think clients know who are the ones that do things well. Because, would a client want to go ahead and risk X amount of dollars [on] someone who's never done industrial before, and then lose out basis points on a potential flip?” Khalfe said.
Similarly, it's not so easy for commercial real estate brokers to pivot from one specialty to another, according to Society of Industrial and Office Realtors Global President Mark Duclos.
In his role, Duclos talks to SIOR chapters all over the country. He has heard of brokers moving from other specialties to industrial over the past year, but those cases have not been frequent. Though industrial may have a “grass is greener” appeal, making the switch right now could appear opportunistic and bring the seriousness of that broker into question.
“I need to worry about my brand in the marketplace. So if I'm known as an industrial broker, I don't want to be sliding over to the office side, because I ruin my brand,” Duclos said. “Now, if you're going to make a long-term move to industrial because you're going to change your brand, that's fine. And maybe some people are doing that. I'm not necessarily seeing that yet.”
A new entrant moving to industrial brokerage could also find it difficult to break in and sign clients, because so many experienced brokers have been in the space for years and have a monopoly on some of the biggest clients.
“I think if you're making that decision, and you're going to go battle with other industrial brokers that are already in your market, that could be a tough haul,” Duclos said.
Occasionally, there has been a successful overlap for brokers on the client side. There are examples of downtown office users that have decided to move into one- or two-story suburban industrial or flex properties. Duclos said clients typically opt to keep their office broker to handle the transaction, even though it may involve a property that was originally intended for industrial use.
“Because their broker has typically been an office broker, that broker is representing him in those transitions to nontraditional office spaces,” Duclos said.
It is more common and accepted for investors to expand into new product lines than for architects or brokers. But stiff competition means the wave of eager investors eyeing the industrial sector may find it surprisingly challenging to get their hands on high-value property, according to Subramanian. She oversees Capital One’s commercial real estate activities in Washington, D.C., including construction loans, term loans and lines of credit to local funds and developers.
“As far as financing goes, that’s one sector where banks and financial institutions [have been] extremely competitive on the financing all through COVID,” Subramanian said. “And now, if you look at rates, and loan-to-values, and debt service coverage, it's very, very aggressive. Because everybody has a very good outlook for the sector.”
Subramanian said some clients looking for financing are building high-end build-to-suit or speculative developments. Others are looking to buy older infill product, which can be transformed into useful last-mile facilities.
The types of companies that are most successful in receiving financing for industrial are those that already have a management team with experience in the sector. Firms that don’t have that will need to go out and find people who do.
“If you can have money, you can hire experience,” Subramanian said.
Subramanian noted that although there is intense interest from funds in buying industrial property, the competition for that property is fierce. Consequently, it is unclear whether new entrants to the sector are having much success.
“These deals get picked up so quickly and there's so much competition that I don't know how successful they're being,” Subramanian said.
Those who have been involved with the industrial sector for years say it’s too late for enthusiastic new entrants to simply muscle their way in. The best chance at success is to offer a product that can be differentiated from others in the market.
Burritt said Gensler does compete against other architecture firms that specialize in the industrial space. Because of the depth of diversity in its practice areas, the firm has the ability to come up with designs that aren’t just run-of-the-mill.
“What we can bring to the table is our experience of other things that might be sort of tangent to that project,” Burritt said. “When they realize that we can help them with that, that really kind of wins the day for us.”
As to whether industrial is just a short-term craze, Subramanian believes that the momentum behind the sector is here to stay.
“I don't think this is a fad. I mean, this is completely related to e-commerce. And that's only going to increase after COVID because people have got used to ordering everything,” Subramanian said.