CBRE Flash Call: Industrial & Logistics Insights

Spencer Levy, Senior Economic Advisor and Chairman of Americas Research

CBRE remains optimistic about the trajectory for the global and U.S. economies, forecasting a bounce back in the 3rd and 4th quarters largely based on the comps from China and the EU that show growing strength and much better “pent-up demand” for retail, hotels and restaurants than many expected.

Equity capital markets have improved since April 1, even with no material change in sentiment, deal flow or pricing, as this relative stability is an important confidence booster. Debt remains available but constrained, especially moving out on the risk spectrum. TALF has been very effective in stabilizing any “bad debt” in commercial real estate.

Some positive news for the industrial sector: while I&L will suffer headwinds over the next year that will soften rents and vacancy, the forecast is actually stronger today for industrial than earlier this year, as the combination of macro and micro secular shifts related to e-commerce, resilience (the need for additional inventory) and longer term reshoring of manufacturing to the Americas (primarily the US and Mexico) will bolster long-term demand.

John Morris, Americas Retail, Industrial & Logistics Leader

CROSS-REGIONAL
Occupier sentiment is more positive overall this week, as most markets are seeing good activity. Big box activity remains strong with larger users in the market, while conversely the smaller size segment is struggling in many markets. Food & Beverage is extremely active with an uptick in cold storage (BTS projects). E-commerce and 3PLs remain active as well. Rents and pricing are holding as landlords maintain rents or in some competitive segments push for higher rates, and the majority of markets have not seen an uptick in sublease space.

MIDWEST REGION
Rents are stable, with the exception of Houston, where they are starting to see rent compression. In some markets (Omaha and El Paso in particular) developers have redirected their focus to industrial from other uses that have been negatively impacted by COVID-19.

NORTHEAST REGION
There’s been a positive uptick in activity over the past few weeks, and activity on larger blocks (250,000 sq. ft. and greater) is the lead market driver. Boston is experiencing new demand from pharmaceutical manufacturing companies. Ecomm, Food & Beverage, Cold Storage and 3PL remain the most active industries in most markets.
 
SOUTHEAST REGION
As more metros and local economies open back up this has led to positive sentiment, and this has been the story in the southeast for a few weeks now. Minimal activity from local users in Florida markets; however, in other markets, particularly Atlanta, local users are active again. Port markets have been impacted by decline in container volumes but expect a bounce back mid-summer.

WEST REGION
Business sentiment is improving overall, with lease rates holding and an increase in cold storage inquiries. Tour activity is up from 3-4 weeks ago, but still not at pre-COVID levels.

James Breeze, Global Industrial & Logistics Research Leader, CBRE
David Egan, Head of Strategy & Consulting, National Partners, CBRE

Data Points from the First 30 Days of Pandemic
From a transactional standpoint, the number of transactions were down 29% in the first 30 days post COVID, which we define as March 15 to April 15, compared with the previous 30 days, but most of that downturn has been in product under 50,000 sq. ft, which was down 37%. We are starting to see a pickup in sublease space, however, with availabilities up 13% in April compared with the previous month. We did find that the markets with the largest increases in sublease space were seaport markets, which could point to a perception of a decline in imports in the short term.

From a development standpoint in April, product under construction dropped by 30 million sq. ft., but pre-leasing remains the same as pre-COVID at about 33%. We do expect ground breakings to drop in the coming months, and this will lead to a pretty significant drop in speculative space hitting the market in the second half of 2021.

Updated Rental Rate Forecast
In the near term, the rent growth that has been prevalent that last five years may stall in 2020 and into the early part of 2021; however, the long-term forecast is very positive. The forecast takes into account sustained, robust demand from sources including e-commerce users, an increase in inventories on shore, and the possibilities of reshoring, compared with that drop in new construction inventory previously mentioned, will significantly boost rents beginning in the second half of 2021. In fact, rents are projected to fully recover and surpass the originally forecasted rents by early 2022 and grow at a rate nearly three times greater than originally expected.

E-commerce and Occupiers
The biggest challenge for occupiers is the final mile, and we are seeing this challenge exacerbated today. Walmart and Target are great examples of this: over the past few months Walmart’s grocery app use has increased by 460%, and there have been similar increases at Target. Most of these purchases are picked up in store, and this will lead to a rethinking of the retail store over time as a more omnichannel facility with a distribution presence in the back and space for pickups on the floor, but that doesn’t mean that demand for industrial final-mile will decrease. In the previous cycle there was a hesitancy to do much redevelopment for final-mile fulfillment centers, but as it becomes a higher percent of overall retail sales, occupiers will be willing to pay more for these locations. This could lead to a significant increase in redevelopment in the coming years.

Chris Riley, Vice Chairman, Institutional Properties, CBRE

Market Data Points
There are few data points in the market as approximately 70% of National Partner’s deal pipeline has been postponed, but we have approximately 30 deals across the country that priced during COVID-19, are in due diligence or have waived contingency and are moving to closing. The majority of the deals moving forward have a core profile (credit, term, at market rents, quality buildings, A locations), and most of these are bulk buildings. Bulk buildings, multi-tenant buildings and truck terminals continue to see durable demand, while light industrial is more difficult to place.

What Has Changed
Virtually all of the pre-COVID-19 investors remain active, but 75% are price point buyers that are seeking a greater discount than sellers are willing to accept. Value-add or lease-to-core opportunities still have an audience, but the MLA’s are more conservative, and the stabilized return has widened by 20 – 50 bps (very market dependent).

New Trends
There has been a flight to quality and risk-averse mentality, and most investors have shifted away from taking leasing risk to a core strategy. Portfolio premiums do not exist like the previous five years; bigger is not better. The sweet spot for deals is $25 - $100 million; this size is more manageable to support at investment committee and tactical to add to a fund. Fund managers remain concerned about quarterly appraisals and how new acquisitions will be valued.
 
Timing to Launch New Offerings
A number of metrics determine when investor demand and pricing is rebounding, and while it remains too early to confidently predict that date, we expect to launch new offerings in the 3rd quarter.

Future Pricing
The industrial sector appears to be poised for a strong recovery with three material secular shifts:

Brad Ruppel, Senior Vice President, Institutional Properties, CBRE

Both the big-box fulfillment centers and last-mile delivery stations have undergone sophisticated, functional paradigm shifts. In last-mile delivery projects, some relevant trends are visible:
There is a groundswell of active capital seeking these opportunities. Based on BOV activity and pre-packaged deal flow, we anticipate merchant developers and re-developers responding to that demand with more frequent purchase opportunities in the remainder of this year.

At the other end of the e-commerce delivery network, and thus the other focus for capital markets, are fulfillment centers.

Shifting to current generation multi-story projects with market rent attributed to usable square footage, the US is admittedly catching up to our UK and European counterparts. There are now a number of active equity investors looking to make an impact on this space in the near term. Several net lease funds are pursuing forward-funding execution.

Tying this all together, investors are demonstrating a greater understanding that diversification under the e-commerce umbrella, gaining exposure to last-mile, sort, non-sort, and specialty fulfillment centers, is a defendable approach to the sector. Capital is pushing toward the logistics single-tenant net lease space as a safe haven investment, and this seems poised to be the market’s near-term catalyst.

Val Achtemeier, Executive Vice President, Debt & Structured Finance, CBRE

We are seeing encouraging improvements in the debt markets although they remain very fluid. Key rate indexes have fallen from levels at the beginning of the year. The 10-Year Treasury is fairly stable now, but Libor dropped dramatically in past 30 days. CRE debt spreads have compressed since early April following all other fixed asset categories, tied to Corp Bond spreads.

Availability of debt is characterized by an overall flight to quality and depends upon lender type. Many still playing defense, but we are seeing bright spots, with lenders back in the market, although conservative and selective. Time to close is being extended up to 30 days due to challenges with physical inspections and slower lender process.

View from Various Lenders:
Banks and LifeCo’s are generally amply supplied, with banks being very selective on assets and sponsorship. Banks have been inundated and distracted with loan requests and portfolio reviews, so they are focused on key clients and careful underwriting. Most LifeCo’s are using floors which lowered over the past two weeks. Relative volume is picking up, and LifeCo’s are still quoting and performing.

For CMBS, new issuance and new originations were closed, but now are cautiously open. “Flex” pricing at closing given the macro environment was a big issue for past three months, and new quotes have wider pricing and more conservative LTV.

Debt funds and other alternative lenders are starting to reenter the market, with debt funds eliminating cash-out refinances. Liquidity pressure changed business, as many debt funds saw margin calls on their lines. The construction loan market is opening up for industrial, although sponsorship reliant.

Overall, despite all the market volatility and disruption, debt capital is increasingly available, and we are seeing clear sizes of improvement. Net rates to borrowers are reasonably attractive for core assets and improving.