Portland Industrial Finishes 2020 with Mixed Results
No major asset class benefited greater from the Covid distruption of 2020 than industrial. As households sheltered in place and traditional brick and mortar retail closed their doors, e-commerce was more than happy to pick up the slack and deliver products straight to your door. Covid likely accelerated a process that was inevitably going to occur anyhow, yet shortened the timeframe considerably. Prior to the advent of e-commerce and the "Amazon Effect", industrial was mostly a business-to-business player providing warehousing and distribution to traditional brick-and-mortar retailers for final delivery in stores. Now industrial is steadily moving towards more business-to-consumer operations as warehouses become the stage for last mile logistics to consumer's homes. This is an important function to understand as these become the drivers for demand in the asset class. Therefore it makes sense that as e-commerce demands took hold, there was going to be more demand than supply on the market as Americans clicked away on their computers. In response, developers and owners nationwide moved as quickly as possible to fill the void and take advantage of new leases to large distribution facilities and last-mile logistics properties alike. It's important to note however, that industrial encompasses more than just warehouse and distribution and other subcategories such as manufacturing and flex did not rise as quickly with the e-commerce tide.
As 2020 finished taking inventory, it was clear that investors were bullish on industrial assets. Large institutional players were increasingly entering the market seeing industrial as a relatively stable investment class with upside potential. Industrial investment volume surpassed retail for the first time in 2019 to take third place and now looks to gain ground on office, which has come to be seen as more risky with higher vacancy rates, pricing fluctuations, and increasing capex expenditures. Increased consumer pressures for "just in time" deliveries means that demand for infill locations providing last mile logistics should only increase, translating to sustained rental growth and occupancy rates in stable markets.
According to NCREIF, industrial quarterly returns dominated the market and gave the highest return on investment of any asset class, particularly on the West Coast. Industrial finished the year strong with 4.68% unleveraged composite total return for private investment properties, fueled by national average rent growth of approximately 5.8% year over year.
Source: NCREIF Property Index
The greatest risks nationally seem to be the concern that at some point supply will catch or surpass demand as development continues to ramp up; however most experts agree that this is still a few years off. Another more immediate concern is that as more investors flock to the asset class, will pricing continue to be attractive and can rental growth and cap rate suppression sustain the investment demands?
Although industrial remained a mostly healthy asset class in the Portland MSA, there are areas of concern to acknowledge that diverge slightly from the national picture. For the most part, supply and demand fundamentals continue to post strong numbers but rental rates in the metro have stalled and have not seen any significant weight average increase for the past four quarters and remain at $0.75 per square foot (NNN).
In line with the stalling rental rates, vacancy continues to climb although it still remains slightly below the national average, posting a Q4 rate of 4.47% overall. The highest vacancy rate was in the Swan/Hayden Island market which posted close to a 10% rate in Q4.
These numbers correlate with the overall negative absorption recorded in the fourth quarter of close to 400,000 square feet. Demand continues to remain steady, but some larger vacancies (ie. Unified Grocers) along with new construction deliveries drove up supply in the region and resulted in the negative figures.
In terms of investment, low debt yields and continued investor demand kept capitalization rates relatively stable throughout the year despite the Covid uncertainty settling somewhere in the 5.5 - 7.0% range depending upon class and location. Anecdotally, investors have told us that quality product in good Portland submarkets with attractive pricing remain elusive, which is a testament to the resiliency of the asset class. The real investment risk in the area is in the mid-square footage, older, low clear height product that faces potential obsolescence as warehouse users look to take advantage of ceiling height, on-site employee and trailer parking and good staging areas; delivery efficiencies rely on these components. Indeed, many pundits point to the fact that warehousing is paradoxically moving to both larger and smaller footprints: larger automated distribution facilities and smaller last-mile product close to residential. That's not to say that Class C industrial in the 50k range won't have its suitors as manufacturing and flex users get squeezed in the marketplace, but you would probably want product that has flexibility for adapting to various space needs.
Overall industrial has fared comparatively well in the face of severe economic and health uncertainties. There may be some stumbling blocks in the future with challenges in the vaccine rollout, unemployment, and more economic turmoil, but industrial seems to have the most upside potential. E-commerce has more room to expand market share as consumers become more comfortable with online shopping and industrial will continue to be the beneficiary of those trends.
About the author:
Michael Hironimus, CCIM is the Certified Investment Advisor and Principal Broker for Duckridge Realty specializing in commercial real estate investment portfolios for high net worth clients and institutions, focusing on market, financial and risk analysis. He is also a faculty instructor for the CCIM Institute, teaching professionals globally in the CI-102 Market Analysis Core Course.
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