Industrial Real Estate Demand Growth is Decelerating

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Industrial real estate―defined as warehouses, distribution centers, flex spaces and other industrial buildings with storage facilities―is one of the few traditional property sectors that has sustained demand in the past five years, earning it golden child status. But that may be about to change, according to newly published research from Deloitte, that predicts that industrial real estate’s growth momentum could be in trouble.

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According to our latest research, double-digit e-commerce sales growth is expected to drive approximately 850 million square feet of additional industrial real estate demand between 2019 to 2023. But while warehouse demand is expected to increase in absolute terms, industrial real estate’s pace of growth is forecasted to slow to around 0.9 percent annual growth, nearly half of 2018 levels.

We are seeing two important macro trends driving this deceleration. First, the supply is expected to outpace demand resulting in higher availability rates: from 2019 to 2020 nearly 510 million square feet of new industrial real estate supply is expected to be delivered, compared to only 421 million square feet of additional demand, according to CBRE Econometric advisors. Second, the cost of capital is likely to increase as the Fed raises long-term rates, placing downward pressure on demand. We expect cost of capital to increase 1.3 percent between the end of 2018 and 2023.

CRE firms that play in the industrial real estate space will need to pay careful attention to these macro forces and how they may impact their own growth. Here are a few important tips that could help CRE owners recalibrate and effectively navigate during demand growth deceleration:

• Smarter location decisioning can help tap into high-growth areas. Locations close to population hubs can help shorten delivery times to consumers and also effectively manage transportation costs, i.e. elevated gas prices. The optimal approach to location decisioning today involves combining traditional factors such as land costs and tax rates with new information types like geocoded data on regional online sales, consumer lifestyle and behavior, and traffic movement. Running analytics on this wider set of data points can help CRE owners understand the impact on the warehouse market in a given area, build algorithms to predict alternative future scenarios, and ultimately make the right retention, sale and acquisition decisions for their portfolios.
• Smarter facilities can be a competitive advantage. As tenants, especially e-commerce companies, look for more technologically advanced and flexible facilities, CRE owners will need to focus on innovating space. For instance, tapping into robotic automation and warehousing models that address demand for smaller and more spread-out spaces can help CRE owners differentiate their assets and even demand rental premiums as competition and supply heat up.
• Efficient warehouses can manage rising costs. As the cost of capital rises, CRE owners cannot rely entirely on newer developments and will need to upgrade and retrofit older properties to improve efficiency. Buildings primed for adaptive reuse could include vacant office buildings, underutilized parking lots and garages, or even empty churches. Simple structural modifications, like adding multi-level facilities for dense and more efficient storage or more cross-docks and doors to facilitate faster deliveries could help CRE owners identify cost synergies but also enhance supply chain operations for tenants.

As 2019 progresses, it will be important for CRE owners to consider that the success factors for industrial real estate a year ago could be vastly different for them moving forward. Thinking about the macro environment now and maneuvering sector strategies to focus on accessibility, intelligence and efficiency will be critical for navigating change.

Steven Bandolik

Steven Bandolik is a managing director with Deloitte Services LP and a senior leader in Deloitte’s real estate practice. Bandolik provides advisory services in capital markets (debt and equity), corporate finance, mergers and acquisitions, investments, strategy, restructuring and reorganization, and asset recovery. Bandolik brings more than 30 years of effective, hands-on real estate investment, finance, development, and asset/property management experience, both as a leader and as a strategic advisor.

Saurabh Mahajan

Saurabh Mahajan is a manager at the Deloitte Center for Financial Services. Saurabh researches and writes on a broad range of themes in real estate, including technology, digital transformation, and market performance. He has nearly 13 years of experience in research and financial analysis in real estate. Connect with him on LinkedIn and Twitter.

Read the June 2019 issue of CPE.