Characteristics of an Industrial Real Estate Hot Spot

October 10, 2018

warehouse workers stocking shelves

There once was a time, not so long ago, when industrial real estate was the “boring” asset class in a CRE portfolio. Sure, it was dependable, steady and predictable. But it was less glamorous, less exciting and often less profitable than shining high rises, glassy office buildings and popular retail spaces.

Then, e-commerce came along.

In 2014, global e-commerce sales reached $1.3 trillion. In 2017, they reached $3.3 trillion. By 2021, they’re projected to reach $4.8 trillion.

Global E-Commerce Sales bar chart - 2014 to 2020

The result is a revitalization of the industrial sector, driven primarily by e-commerce retailers looking for warehouse space that meets their specific needs.

On paper, that looks like decreased industrial vacancy, increased rents and industrial sector construction rates that grew by over 34 million square feet in just one year.

Metric Q2 2017 Q2 2018
Overall Vacancy 5.3% 5.0%
Net Absorption 61.2 million sq. ft. 64.1 million sq. ft.
Under Construction 232.9 million sq. ft. 267.2 million sq. ft.
Rent Growth 3.6% 7.2%

 

Driving the Push for Owner-Occupied Industrial Space

Rising rents are one of the single biggest motivators for tenants to pursue the purchase of their own buildings. In many industrial real estate hot spots around the country, lessees are feeling pressure from average rents that are raising significantly every quarter.

In hot markets, a tenant who’s coming off a three- or five-year lease could be facing an increase of between 15% and 30% to renew their lease for the exact same property.

When you compare constantly rising lease payments with the advantages of a fixed-rate SBA 504, owning their own warehouse property becomes an increasingly attractive proposition for many business owners.

Let’s take a look at a hypothetical from one of the current hottest markets in the country: California’s Inland Empire.

Imagine an e-commerce business renting a 77,000-square-foot warehouse in the region. Based on regional averages, they’re likely paying $0.57 per square foot, or about $44,000 per month in rent.

There’s currently a 77,000-square-foot warehouse listed for sale in the region for $8.6 million.

With a 25-year SBA 504 loan at 6%, our hypothetical e-commerce business could purchase that property with just 10% down, with a monthly loan payment of under $50,000.

That scenario is nearly cash flow neutral today, and if rental rates continue to climb in this sector as they’re predicted to, it’s likely that in the near future, the decision to buy would be improving cash flow every month. Never mind the value of the building they now own.

 

But, not all industrial properties and markets are created equal. There are specific characteristics that e-commerce retailers, logistics and distribution centers are looking for. Properties that meet these characteristics are among some of the hottest industrial real estate in the country.

So, what are they? Let’s dive in.

 

Close to Lots of Customers Who Want Things Fast

Amazon and other retailers have conditioned online customers to expect things fast. Two-day shipping, once a luxury, is now often seen as the bare minimum. And overnight or same-day delivery is becoming the new norm for many retailers.

Of course, fast delivery isn’t free. And if retailers want to negotiate better rates with shipping and logistics companies, they have two options: Ship enough volume to have a strong negotiating position, or ship products from closer to their customers.

Many smaller retailers who aren’t Amazon are relying on the second strategy, which means strategically locating warehouses and distribution centers close to major metro areas. This lets them reduce the distance between them and their customers, and reduce two-day, overnight and same-day delivery costs.

The result is an incredibly hot industrial property market near major metro areas. Transwestern recently released its second quarter 2018 U.S. industrial real estate outlook.

It revealed that currently, the top three industrial markets with the most absorption in the last year are:

  • The Inland Empire, Calif.
  • Dallas / Fort Worth
  • New Jersey

What do they all have in common? Relatively affordable land that gives easy access to some of the biggest pools of consumers in the country.

The Inland Empire is right next to the Los Angeles metro, New Jersey is right next to the New York metro, and Dallas / Fort Worth of course provides easy access to the Dallas metro.

Online retailers are snapping up industrial space for warehouses in markets that let them get their products to large swaths of customers, quickly and affordably. If you’re looking for an industrial real estate hot spot, look at the outskirts of a major metro area, where logistics companies can acquire land relatively cheaply, with good transportation links and the ability to reach customers in that metro in a matter of hours.

Key Factors

  • Proximity to major metro
  • Affordable land
  • Good transportation links

 

Advanced Technology to Do More With Less

Megawarehouses are the exception, not the norm. Research from JLL shows that about 60% of new warehouse development is made up of facilities between 50,000 and 250,000 square feet. With small and midsize warehouses making up the bulk of new development, owners are looking to technology to improve efficiency.

Additionally, e-commerce warehouses can look very different from traditional warehouses. The pace of e-commerce warehouses is staggering, with thousands of outgoing customer shipments, along with incoming shipments of goods and returns, being processed every day.

Owners and operators are implementing a variety of technologies, but they all rely on one core feature: network connectivity. In terms of data flow, a modern e-commerce warehouse can resemble a data center of just a few years ago. They’re likely hosting a range of connected technologies, from RFID and barcode scans to GPS, picking optimization and IoT connectivity. The ideal connected warehouse has fast, redundant network connections to make sure that connectivity is never a bottleneck.

Many warehouses are also implementing various levels of automation. These can range from AI-driven picking and guidance systems, to semi-automated conveyor and shuttle systems, to fully robotic picking systems and even barcode-scanning drones. All of these systems require flexibility, space and custom buildouts to implement.

Key Factors

  • High bandwidth, redundant network connectivity
  • Flexibility for automation integration

 

Building Up, Not Out

In the past, 24- to 26-foot ceiling heights were the norm. But as owners place a premium on proximity to large cities and technology alleviates barriers, ceiling heights are growing. Today, typical in-demand ceiling heights are in the 36- to 40-foot range.

Besides space efficiency, a few key technologies have allowed this shift to take place. The first is improved picking technologies and automation. The more automated picking becomes, the less of an obstacle reaching high storage locations becomes. Second, more advanced, automated LED lighting systems allow for improved illumination, from the floor to the ceiling. Finally, more advanced fire suppression tech allows for higher ceilings without increased fire risk.

Key Factors

  • 36+ foot ceiling heights
  • Advanced automated lighting
  • Advanced automated fire suppression

 

Human-Centric Design

The other week, Amazon finally responded to the raft of criticism it had received about its poor treatment of warehouse workers: by raising its minimum wage to $15/hr. This move is illustrative of a larger trend among warehouse operators of paying closer attention to the human element in their operations.

Even as automation replaces some human tasks, a skilled, motivated and dependable workforce is more important than ever, and warehouses are operating in a tight labor market.

Human-centric design in warehouses improves employee satisfaction and happiness, along with reducing turnover, cutting injury rates and improving efficiency.

Key Factors

  • Human-centric facility design
  • Appropriate lighting & ventilation
  • Well-designed employee facilities
  • Ergonomic design

 

Sustainability

Many brands place sustainability as a top priority; and features like solar power, LED lighting and green materials have gone from the fringe to the mainstream. Often, this is about much more than simply “being green”; it’s about cost savings.

Many of the hottest warehouse and industrial markets in the country are in states that offer significant cost benefits for energy reduction and conservation measures, including renewable energy. And even without those incentives, many sustainable initiatives make sense simply from the perspective of the bottom line.

Key Factors

  • Energy-efficient lighting & HVAC
  • On-site renewables
  • Sustainable building techniques and materials

 

Putting It All Together

Industrial CRE is no longer the “boring” asset class it may have been a decade ago. Today, it’s one of the hottest asset classes in the country, driven primarily by a growth in e-commerce logistics. When you understand what’s driving this sector and the key factors that warehouse owners are looking for, you can easily steer your clients toward the right locations and properties to fit their current and future needs.

And remember, if you ever need an outside perspective, particularly on owner-occupied industrial facilities, our entire team is ready to help.