At I.CON Virtual 2020, JLL President of Industrial Brokerage Craig Meyer and Prologis Global Head of Customer Led Solutions Jeremy Giles had a candid discussion about how industrial real estate has fared during the novel coronavirus crisis and their future expectations for the sector.
Recent Demand Trends
Meyer and Giles began with an assessment of how the virus has affected demand trends since this February. Meyer observed that the sector began the year in a very strong position – the best market for industrial properties in the last three or four years – with vacancy rates at an all-time low in the first quarter. Strong market conditions at the beginning of the year have helped the sector weather economic shocks related to the pandemic. Giles observed that the outbreak’s effects on the sector “definitely unfolded in ways we would never imagine.”
In February, operators in the U.S. were primarily concerned about the outbreak in China leading to disruptions in production and shipping that would lead to stockouts, but conditions in China stabilized relatively quickly and shipments resumed in March, just as the outbreak became a major problem in the U.S. Instead of facing a supply shortage, a sudden economic downturn sharply decreased demand for a range of consumer goods. Retailers have essentially missed the spring season and the back-to-school season is also at risk, contributing to a glut of products that are still waiting to be sold.
Meyer noted that despite the unprecedented economic shock associated with the pandemic, fundamentals for the industrial sector have remained strong. “I’m pretty surprised about the resilience of our business.” According to Meyer, only about 10% of industrial tenants had asked for rent relief, and these were concentrated in tenants within properties smaller than 100 thousand square feet. Developers and owners of larger warehouse and distribution centers in major markets have easily been able to lease these properties, though owners focused on serving bricks-and-mortar retailers and those located near the ports of Los Angeles and Long Beach have seen more of a downturn in demand. Giles revealed that space utilization among Prologis’ customers remained high (84.5% in May).
Going forward, both Meyer and Giles said they expect that the industrial sector will perform better than it did during the global financial crisis and are optimistic about the trajectory of the U.S. economy. Meyer said he expects that the U.S. economy will return to growth sometime in the second half of the year, but will take a couple of years to fully recover. At this point, the industrial sector has not gone through a substantial contraction. Prologis has experienced vacancy rates around 4.5%, much lower than peak vacancy rates of around 10% in 2010. That said, speculative industrial development has slowed down substantially as financing for speculative development has become difficult to obtain.
Trends Affecting Demand: E-commerce and Shifting Supply Chains
Meyer and Giles see growth in e-commerce as the primary reason that the industrial sector has performed relatively well during the crisis and expect this trend will continue to support demand growth going forward. “Is e-commerce going to save us all?” Meyer asked rhetorically. “For the time being, probably yes.” Although JLL expects that online sales will decline from a recent peak of 26% of all sales, it will likely remain in the low 20s for the near future. This should lead to continued demand for last-mile facilities. Giles observed that the current crisis has led to growth not only in total online sales volume, but also the number of e-commerce customers, and that related demand growth will likely be sticky.
Both panelists also expect that disruptions associated with the pandemic will lead to changes in how supply chains are structured. Giles noted that supply chain managers had focused on efficiency, just-in-time logistics and reducing costs in recent years. Now, Prologis is hearing customers talk about stress-testing their supply chains so they can withstand future shocks. Giles said he expects this will lead operators to carry more inventory and diversify supply chains so that they are less reliant on shipments from China. Meyer agreed that there is a trend toward diversifying supply chains, though a significant amount of production will likely remain in China. He said he expects that the supply chains most likely to be reshored are those pertaining to pharmaceuticals, medical supplies and other goods that are critical in a crisis. However, he also noted that these industries do not occupy nearly as much space as e-commerce, and are likely to have a modest impact on demand for industrial real estate. Diversification in other sectors, such as the automotive industry, will also likely lead to more supply chains originating in Mexico.
Trends Affecting Supply: Labor Shortages
Although unemployment remains high across the U.S. economy, logistics operators remain constrained by labor shortages. According to Giles, labor receded as a hot-button issue for Prologis’ customers in the first couple of months of the crisis, but is again a major concern. The surge in demand for e-commerce has required logistics operators to function on schedules they normally reserve for the holiday season. Even with employees working around the clock, one third-party logistics provider is only able to operate at 80% capacity because of labor constraints. These constraints will likely continue to be a challenge for the industry. Logistics operations related to e-commerce are labor-intensive and will continue to be for the foreseeable future.
Giles said he believes that the coronavirus pandemic will likely contribute to a recent trend toward more amenities and a growing emphasis on health and well-being in warehouse and distribution centers. These trends have included the development of WELL-certified industrial buildings, which help with worker recruitment and retention. Since the novel coronavirus outbreak, operators now also need to lower the risk of infection by spreading workers out, and some are exploring the installation of infrared sensors to screen workers for fevers. Giles expects that labor shortages and safety concerns may also contribute to more operators using cobots to assist workers in logistics facilities.
Meyer and Giles said they expect that additional amenities, such as onsite daycare facilities, will also become increasingly common. Giles observed that, given the limited supply of logistics workers, “our customers are looking for any advantage they can in the building and the amenities that are offered” to attract employees.
Redevelopment Opportunities in Retail Centers
Meyer identified one additional trend that could potentially emerge from the current crisis: the redevelopment and repurposing of closed retail centers. There has been a lot of discussion about whether and how to repurpose individual stores or entire malls that have closed during the crisis. Redevelopment of closed retail centers will require partnerships with local governments to obtain needed entitlements and meet community expectations. It may also require that developers work closely with retailers to develop mixed-use buildings that retain a retail function. Redeveloping these properties will not be simple, and will require innovation. Meyer said he believes that the developers “who can figure it out first will profit the most.”
As NAIOP Research Director, Shawn Moura manages the NAIOP Research Foundation research committee and day-to-day operations of the Foundation’s research projects.