CHICAGO–“There’s plenty of room to run,” for the industrial market, says Al Pontius, SVP and national director, specialty divisions, for Marcus & Millichap’s Institutional Property Advisors. Little wonder. The asset class–especially A assets–is enjoying compressed cap rates, interest from a growing diversity of investor types and growth in markets never once considered amenable to industrial.
In all, says Pontius, “It’s a robust sector that’s outperforming all others. There are great fundamentals and great investment activity at all levels.” The sector has strength enough to counterbalance the potential headwinds all product types are facing in the current “rising interest rate environment.” In fact, according to Marcus & Millichap’s Midyear 2018 Industrial Report, core inflation has risen 2.3 percent.
Nevertheless, “we’re building 260 million square feet of new inventory a year,” Pontius says. “That’s a lot of industrial. But this is the seventh year to out-absorb all the new inventory. Demand drives everything.” Even when you fold in the fact that nearly half of that is being built on spec.
A growing percentage of that demand is being driven by e-commerce, he says, which means that there is a geographic expansion taking place. According to the Marcus & Millichap report, second-quarter online sales rose by 15.2 percent over the same quarter last year. As a result, in addition to the must-have industrial locations, such as Chicago, Los Angeles or New Jersey, distribution warehousing to fulfill e-commerce is also driving cap rates down in high-growth populations, such as Phoenix, Denver and Nashville.
But it’s not all about e-commerce, and manufacturing is holding its own, Pontius explains, and “onshoring of manufacturing has improved in places that have the labor, such as Detroit. Clearly they’re doing much better than they used to.” Not surprisingly, manufacturing is also seeing the impact of technology as a growing number of tenants come with demands for automation and more power.
Industrial by the Numbers
The numbers clearly support the exuberance surrounding the market. Class A industrial cap rates on a national average have compressed about 10 to 12 basis points over the past year, Pontius says, pushing pricing up by five percent year over year. Not surprisingly then, rents are also on the rise, by an estimated six percent.
In addition, investment volume is rising. “We’re about 20 percent above 2017 volume levels, or about $30 billion for 2018,” says Pontius. “So, obviously industrial is performing and people are investing in it aggressively. We have foreign capital in addition to the institutional capital that has always been there.
“We also have private capital,” he adds, “which has been a relatively new development over the past few years. Now it’s coming in droves.” There are two basic reasons for that push, he says. First, obviously, is the performance of the sector. In addition, he says, “It doesn’t require the huge investment of capital or suffer the same volatility of an office building.”
Interest is especially strong in California, Pontius reports, where Proposition 10 has investors rethinking their placement of capital in multifamily. “Those investors are selling those buildings and moving money into industrial.”
If a brand new industrial building of 250,000 square feet will trade at $80 a foot, “you’re looking at deal sizes of $20 million to $30 million for functionally awesome buildings,” the Marcus & Millichap IPA executive points out. “That’s a chunk that sits nicely with private investors but with banks and life insurance companies as well, which increasingly are adding industrial to their portfolios.”
So, indeed, there is room to run, and Pontius predicts that the market will be replicating this success through 2019. It will be “another good year for industrial,” he concludes.