By Aidan Hume
In the late 18th century, there was a massive shift in the U.S. economy at the hands of the Industrial Revolution. Once dominated by agricultural production, our country began to transition to new manufacturing processes that increased demand for machine tools and factory systems.
From mill buildings whose location was determined by fast moving water, to warehouses with the necessary proximity to railroads, the heightened demand for this type of work created immense value for industrial real estate, a type of property that has played a vital role in the economy ever since.
As the market has evolved over the following decades, most of these spaces went on to be replaced by other types of real estate that were perceived to be for higher and better use, such as luxury skyscrapers, manicured residential communities, or shopping centers and high-end retail space.
Almost 200 years later, industrial real estate is stepping up to the forefront again.
Over the last few years, we have seen an increasing trend of big box shopping malls being converted to warehouses. This type of real estate, now more flexible in its use, is scattered across the country and has been veering back toward industrial as countless existing retail establishments have closed their doors and morphed into semi fulfillment centers. Even office space, in some cases, has been redeveloped as industrial.
Nationally, we have witnessed eight consecutive years of positive absorption in the industrial market. As a result, banks have been hard at work to adjust their allocations as industrial real estate gains greater favor amongst investors. Just like that, industrial has become the type of real estate perceived as higher and better use.
This national phenomenon is also occurring in the Greater Boston market. For example, vacancy rates market wide are sub-5% and we have seen an approximate 60% increase in rents since 2016. Buildings that were once thought to be obsolete are now being renovated and becoming the only option for specific tenants priced out of their higher rents. Several forces have combined to create and further industrial real estate’s rebound.
· E-commerce continues to grow with increased demand for last minute distribution
· Pandemic shortages have created a shift in production and supply chain practices away from Just-in-Time inventory to Just-in-Case, resulting in higher stockpiles that require more space
· A new desire to “onshore” critical goods and components because of both the pandemic and trade concerns
· Increased demand for GMP (Good Manufacturing Practice) space which provides for basic standards and systems that assure proper design, monitoring and control of manufacturing processes and facilities
· Growth of food & beverage e-commerce creating additional demand for cold storage space
This begs the question, is industrial real estate a seemingly bulletproof investment? The current environment lends value to this type of real estate because there has been very little transaction activity in the office and retail sectors since the onset of the pandemic, allowing for greater competition for industrial assets and driving prices up. The events that have unfolded over the last two years have been unpredictable and what will happen in the years to come is anyone’s guess. That’s why it is important to identify the risk that is associated with investing in any type of real estate by asking yourself:
· Are we in a bubble where cap rates have declined significantly with the increased investor appetite?
· Is the growth in rent rates sustainable?
· Will we see overbuilding and too much speculative space?
There is no question that these risks are real, and that industrial real estate will continue to go through the normal ebbs and flows of property cycles, however the appeal of industrial real estate as an asset class has been significantly enhanced. Class B space that was once the preserve of family investors and owner occupiers is now sought by institutional investors. The pandemic has created many questions on the future viability of other product types but seems to have accelerated the demand for industrial space and increased the appeal for this property type as an investment. While this trend was augmented by the recent economic crisis, it was already underway and is backed by solid fundamentals that should continue to generate demand in a post pandemic world.
(Aidan Hume is the Senior Vice President of Commercial Real Estate at Cambridge Savings Bank. He has 25+ years of experience in all phases of lending and holds the Chartered Financial Analyst (CFA®) designation.)