Industrial Rents Are Rising So Fast, Developers Aren't Sweating Construction Costs
The ongoing and overlapping disruptions to the global supply chain are wreaking havoc on retailers, construction firms and developers in most sectors of real estate. But so far, that havoc is playing out in favor of those who own and build distribution centers.
Among the first dominoes to fall in the chain of events that caused such chaos for international shipping was a spike in demand for products sold online and delivered to consumers’ homes. Enough of that demand has remained for all kinds of companies to see the need for a more robust distribution network. As a result, industrial rents have grown enough to offset the increased costs plaguing any company that wants to bring goods to the U.S. from overseas, panelists at Bisnow’s Philadelphia Industrial Outlook event on Oct. 7 agreed.
“The reality is that with the demand that we're seeing from the tenant base, all of that increase [in construction costs] is being mitigated by the increased rent tenants are willing to pay,” JLL Northeast Industrial Region Senior Managing Director Larry Maister said. “So at this point, although we're seeing increases in construction costs, the rental rates that we're achieving are far superior.”
Manufactured components like roll-up doors for loading docks can now take as long as six months to arrive, compared to the three to five weeks that were expected before the coronavirus pandemic, Duke Realty Assistant Vice President of Acquisitions Seth Hall said. Ordering what one needs to complete a building confers the advantage of being virtually first in line to receive the components, and thus be more certain of when the project will deliver when marketing to tenants.
“Right now, it’s all about speed to market,” Hall said. “I think whoever gets there first is going to have an advantage.”
While the advantage of speed to market may lead some developers to start marketing their properties for lease as soon as they can confidently project a delivery date, rents have been rising so rapidly that pre-leasing a speculative building that is still under construction might no longer be preferable, Hall said.
Considering the urgency with which tenants are looking for space, waiting until a project is delivered can produce higher rents just by virtue of a couple of months having passed, in addition to the premium that one can charge for move-in-ready space. And while this type of story is playing out all over the country, Greater Philadelphia is outperforming nearly every other American market in terms of both leasing velocity and speed of delivery to consumers.
“Within our portfolio, [Philadelphia] is the best-performing market we have nationally,” said Matt Brodnik, chief investment officer for EQT Exeter, which was known as Exeter Property Group before it was acquired by Swedish investment firm EQT AB earlier this year. “Our downtimes are the lowest here.”
Brodnik described a recent conversation he had with an investor from a “small Asian city-state,” wherein the investor, likely from Singapore, told Brodnik that EQT Exeter’s rent projections for the Philly region were too low.
“Philadelphia is on the map — the world map,” Brodnik said. “It’s not second chair to New York or Washington, D.C.; it’s among the best-performing markets in the world.”
Whereas before the pandemic, industrial real estate in Greater Philadelphia was most valuable in the Lehigh Valley and parts of South Jersey, it matters less than ever where a distribution center is located, as long as it is reasonably close to major highways and Philadelphia itself, multiple panelists said.
South Jersey has become popular enough to blur the financial line between itself and North Jersey, long considered a tier above for its proximity to New York and the Port of Newark, while rents have finally grown enough to justify redevelopment of many former manufacturing plants within Philly city limits, Transwestern Development Co. Logistics Group Partner Greg Boler said. The value proposition grows even more when considering the struggles some developers have had getting suburban townships to approve new ground-up development in their jurisdictions.
“Now the rents are there, so you can get very creative with all of the older product there that's already by-right,” Boler said. “And you can do a good amount of redevelopment, and that's the fun part.”
Panelists unanimously agreed that despite the steep increases in rent over the past year, there remains significant runway for further growth. Part of that comes down to the elevated e-commerce usage of consumers that appears to be permanent and that companies now are looking to expand industrial capacity stateside to provide a bigger cushion for their inventory in the event of more global supply chain disruptions in the future. The fact that by and large, investors seem more willing than ever to accept lower yields for warehouse properties speaks to the market’s overall confidence in its ability to absorb further rent growth.
“There’s just so much capital in industrial right now that on the equity and the debt side, they’re willing to take more risks, so their spreads are going to be lower than they are today,” Boler said. “So merchant developers like myself, we're really going to be pushing more on the rent, knowing that we can exit [the property] at just a crazy cap rate.”