An accelerating e-commerce trend and a rethink of supply chain practices augur well for US industrial property over the long-term.
Eager to climb aboard the rising tide of e-commerce, Australian institutional investors have increasingly been looking to increase their exposure to industrial property.
With limited opportunities in the burgeoning local market, many investors have been starting to look offshore to increase their allocation to industrial assets – particularly to the US, the birthplace of e-commerce giants such as Amazon, Walmart and Wayfair.
But what does COVID-19 mean for the sector?
While few industries around the world will be immune from the economic fallout from the COVID-19 outbreak, there is good reason to believe the industrial sector will remain resilient relative to other real estate sectors.
Indeed, when the virus is brought under control, social distancing measures are lifted and economies rebound, the sector could emerge stronger than ever.
We have observed three-step changes in the US industrial and logistics industries brought about by the COVID-19 outbreak that are likely to contribute positively to the sector’s long-term investment appeal.
1. Accelerated adoption of e-commerce
Online retailers in the US are ramping up their businesses to respond to surging demand for online shopping as physical stores shut their doors and consumers across the country are forced to shelter in place. Amazon has announced it will hire 100,000 workers for its fulfilment centers and transport operations and increase the pay of existing workers as it seeks to meet the elevated demand. Many consumers who otherwise would not have previously ventured to make a purchase from Amazon via their phone or mobile device are now placing online grocery orders weekly. While the conversion to online purchasing has been somewhat foisted upon them by circumstances, it’s likely that after experiencing the ease and convenience of the process of online shopping, many people will continue to order more products online after social isolation restrictions are lifted. It’s this rapidly accelerating adoption of e-commerce caused by COVID-19, along with the impending rollout of the high-speed 5G network in the US that stands to truly exacerbate an already robust behavioural trend towards online shopping. And as that online commerce pool expands, we know that industrial demand in the US will follow. Currently, each US$1 billion of incremental e-commerce retail sales growth equates to 1.25 million square feet of industrial demand growth in the US market – a meaningful statistic.
2. Rise in inventories projected as e-commerce industry learns from crisis
Another significant change we are beginning to observe as a result of the COVID-19 outbreak is that companies are contemplating the need to hold greater amounts of inventory to buffer their future supply-chain responsiveness. Nearly 75 per cent of US companies have experienced supply chain disruptions because of virus-related transportation restrictions, doubling lead times for a majority of businesses, particularly those importing goods from China, according to a survey by the Institute for Supply Management*. Armed with a heightened awareness of the negative impact supply chain disruptions can have on their business, many companies are now realising the need to keep deeper product stocks on hand, which is increasing their projections for future warehousing needs. Early indications from management of publicly listed industrial real estate investment trusts (REITs) in the US have indicated a potential 5 per cent to 10 per cent** increase in inventories being held by their tenant base as a result of this trend.
3. Onshoring and reshoring likely to gain momentum
As the risks inherent to global supply chains have become more apparent, some companies are fundamentally rethinking where they produce their goods and how they configure their supply chains. Stability is supplanting efficiency as a top priority. Many companies that currently base a significant amount of light assembly and manufacturing operations in foreign countries, such as China and India, where they are able to access lower labour costs and overheads, are now reconsidering this model. Exposed by the COVID-19 pandemic, a number of large corporations have now come to the realisation that the cost of supply chain interruptions far outweighs the incremental cost of domestic labour, and they are registering the need to prioritise proximate access to inventories and more localised warehouse and manufacturing locations. This trend, as it continues to pick up momentum, will continue to have users of industrial facilities looking to “reshore” supply chain locations back to the US.
A defensive asset in volatile times
These recent developments bode well for industrial real estate over the short and long-term as they will provide an additional boost to already robust demand for high-quality, well-located bulk warehouses and light industrial properties.
The economic downturn that results from the COVID-19 outbreak will have implications across the real estate industry. However, the industrial sector does have some defensive characteristics and structural tailwinds that have made it relatively resilient in prior times of volatility.
Firstly, construction lead times for the industrial sector are relatively short when compared to other sectors of the real estate market. A building can be constructed in six to nine months. This provides the ability for incoming supply in the US to be eliminated promptly if there is an unexpected fall in demand. This has a smoothing effect on market cycles, reducing volatility in asset values and rents while normalising supply and demand balance across markets.
In addition, there is historically a very low capital expenditure load within the sector. In times of volatility, assets that require smaller capital inputs can be very appealing because of their capacity to preserve investor returns. In instances where tenant rollover occurs, this lower capital expenditure need allows warehouse owners to spend far less than landlords in other real estate sectors to give the property a refresh and secure new tenants. We can preserve occupancy and cash flow with less capital investment, and savvy investors are recognising the appeal of this, particularly during economic downturns.
Strong long-term fundamentals
Transaction volumes in this sector are currently subdued as buyers and sellers cautiously await more certainty over the efforts to contain the virus and the economic fallout. However, once the virus is contained and the economic impact is quantified, the sector will refocus on the underlying forces of supply and demand, and the fundamentals in this regard are robust.
Demand for light industrial real estate has been outstripping supply for some time, leading to higher rentals and asset values, due to the already rapid uptake of online shopping. Online retailers require large logistic operations to support inventory, packaging and delivery requirements to meet growing e-commerce demand from consumers.
As the popularity of online shopping continues to grow, that demand from occupiers will increase further. Not only do consumers want more goods online, they want them faster.
As retailers and logistics firms race to deliver faster and faster services, demand is rising for light industrial properties with close proximity to the center of major cities.
Why the US? – isn’t it too late to ride the e-commerce boom?
In Australia, the industrial real estate market is growing fast but it is relatively small compared to the US. Some investors ask whether it’s too late to benefit from the e-commerce trend in the US given it is a more mature market.
The answer is no. It is not too late. Far from it. E-commerce penetration in the US is significant but it continues to grow and is a big demand driver in the industrial space. As mentioned, each incremental US$1 billion in e-commerce retail sales equals about 1.25 million square feet of incremental industrial demand. When you think that online retail sales of goods are expected to rise from 9.5 per cent to 12 per cent of all retail sales in the US by 2025***, that equates to several hundred billion dollars’ worth of e-commerce-driven expansion, bringing with it a massive amount of demand for additional space.
The e-commerce market is currently at an inflection point in the US with 5G technology on the precipice of being rolled out. The arrival of 5G will fundamentally change mobile computing and lead to more efficient and personalised e-commerce experiences, further accelerating the shift to online retail.
There is no denying that we are living through challenging times. The COVID-19 crisis is having a significant impact on human health and wellbeing and the impact of measures to contain the virus will be felt across the global economy. The industrial sector won’t be immune to a downturn in economic growth, however the accelerated take-up of online shopping and the defensive characteristics of the asset class suggest it has the potential to be an outperformer in the real estate sector. In times of uncertainty, investing in a research-driven open-ended fund vehicle in this sector provides diversification and self-arbitrage across both markets and assets, acting as a powerful tool to mitigate volatility.
Over the longer-term, the unstoppable e-commerce trend makes industrial property one of the most attractive sectors of the commercial real estate market. Given Australia has the fourth-largest pool of retirement capital in the world, the rebalancing of real estate portfolios toward industrial will continue to require institutional investors to go offshore for investment opportunities in this sector. The US market remains an attractive option with a vast array of compelling investment opportunities compared to the Australian landscape.
Gray Bouchillon, managing director, head of industrial sector, Americas, Nuveen Real Estate
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