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After Years Of Explosive Growth, Investors Wonder What's Next For Industrial

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The tightening grip that the internet has on the world of retail means demand for fulfillment space is only set to increase. But even though industrial real estate remains red-hot, investors are increasingly cautious about the deals they go after.

Prologis' multistory warehouse facility in the Bronx
Prologis' multistory warehouse facility in the Bronx

The industrial sector has seen explosive growth over the last decade, thanks to a double hit of economic expansion and e-commerce market disruption driving demand.

But some predict frothy prices, increasing supply, labor shortages, tariffs — and the cyclical nature of markets means there will be some form of pullback in the industrial space.

Across all asset classes, real estate players are starting to prepare for the impact of a possible global downturn — and to predict how it may affect certain markets. The industrial outlook still appears rosy from a fundamental perspective, but investors are now being very thoughtful about their deals, carefully analyzing risk and finding creative ways to enter the market, sources said.

“People recognize that it’s been over seven-plus years now with a bull market in this industrial space,” said Seagis Property Group partner Omer Mir Ahmed, who is speaking at Bisnow’s National Industrial & Logistics Summit in New York City this month. “Over the next 12 to 18 months, people will be monitoring risk carefully. They are looking at creative opportunities and they are assessing the risk associated with those opportunities.”

After Years Of Explosive Growth, Investors Wonder What's Next For Industrial
Refrigeration machinery at a WBS Equities facility in Alabama

There is no doubting the fundamentals around industrial real estate remain red-hot.

Rents are at record levels, and demand is still outstripping supply. Nationally, absorption exceeded new supply by 6.3M SF in the fourth quarter of 2018 according to CBRE, marking the 35th consecutive quarter with positive net absorption.

The overall availability rate dropped 10 basis points from the quarter before to hit 7%, the lowest level in 18 years. As a result of the delta between demand and supply, net asking rents hit $7.37 per SF, which is the highest rate since at least 1989.

“We are building spec, [and] we are pretty confident relative to the horizon,” said First Industrial Senior Investment/Development Officer John Hanlon, whose company owns industrial properties across the country. “There are a few markets out there that we think are getting a little bit of oversupply right now, so we monitor those. But generally, we see all good things for the foreseeable future.”

For example, Central and Eastern Pennsylvania have a number of 1M SF properties that are either built or under construction, and the company is closely tracking the absorption rate.

Some parts of Dallas, he said, have seen a little bit of oversupply, though other submarkets there are performing well.

“At some point there will be a pullback, the economy will reassess at some point. I don’t think we are there yet,” CBRE Senior Managing Director Chris Zubel said. “Traditionally, industrial real estate was tied to GDP, so if GDP went up, rental rates went up, absorptions would go up … Over the last five to eight years, we’ve seen additional demand because of e-commerce sales.”

Zubel expects cap rates to remain low, prices to remain strong, and he noted that along with REITs and domestic investors, sovereign wealth funds are increasingly entering the space.

“We are in year 10 of an economic expansion, you have to be asking that question,” said JLL Vice Chairman of the Northeast Industrial Region Robert Kossar about industrial real estate’s ability to whether a downturn — when and if it comes. "JLL’s house view is we have some runway … [in any form of downturn], industrial will push through. We do expect it to be fairly strong and steady.”

He also points to strong fundamentals — chiefly that online retail is now around 8% of all sales in the U.S. and is expected to reach 46% by 2023, according to Statista.

“Smart people are staying disciplined,” said WBS Equities President and CEO Wendy Berger, who is based in Chicago. “I do sense that, while there is still a lot of money out there, the view of the deals or the financing or underwriting is getting tighter.”

Her company focuses on built-to-suit food manufacturing buildings. 

She said investors, particularly institutions, are thinking more creatively about the deals they are chasing — particularly as competition for those deals has intensified and prices have gone up.

What may have not piqued their interest in the past is now getting attention.

“What has changed in the food space is there were not institutional players five years ago," she said. "In the underwriting, they would say, ‘What if the tenant goes out?' Now, the thinking has changed.”

After Years Of Explosive Growth, Investors Wonder What's Next For Industrial
Blue Rock Construction's Thomas Meagher, developer Dov Hertz and Sitex Group's Zach McHugh

Ahmed, whose company is planning to start development on a 415K SF industrial building in northern New Jersey this spring, said that many investors will consider deals with “more hair on them” — meaning entitlement risks or unusual locations.

There are fewer deals around, so developers are forced to think creatively in what is widely considered to be late in the cycle.

“The scarcity and competition on acquisition opportunities has led people to look at deals that are smaller in nature, or have creative aspects such as mixed-use component," Ahmed said. "Like a warehouse that also has a self-storage component, for example."

Some see the fundamentals as supportive of enough industrial development to feel comfortable forging into new territory.

DH Property Holdings founder Dov Hertz is joining with Bridge Development Partners to build a four-story, 1.3M SF multistory warehouse on the 18-acre Sunset Industrial Park site in Brooklyn. The center would be the biggest of its type in the country.

His company is also planning a multistory warehouse at 640 Columbia St. in Red Hook, backed by Goldman Sachs Asset Management.

“Institutional equity has not yet flooded into the [multistory] market, because institutional equity waits until the model is proven out, and then they come in,” he said, though he added there have been some “visionaries” like Goldman Sachs and Banner Oak that have partnered with him.

“Ultimately, will they? Yes, but we believe by the time the model gets proven out, there won’t be much left in the way of land to develop.”

Hear Hertz, Berger, Hanlon and more at Bisnow's full-day National Industrial and Logistics Summit in Midtown Manhattan March 28.