The coronavirus and OPEC price war has punished risk asset prices, and real estate investment trusts (REITs) have been no exception. When the markets stabilize, we believe new and persistent economic dislocations, patterns of consumer/enterprise behavior, and social distancing orders will impact property types differently. One potential bright spot is industrial REITs which could benefit from a host of factors including the race among e-commerce providers for faster home and office delivery, a limited supply of well-located assets in many markets, acceleration in online shopping and greater demand for no-touch home delivery.
Potential tailwinds for industrial REITs. Industrial real estate encompasses several property types, including logistics, manufacturing, research & development facilities, showrooms, and flex properties, among others. As one of the four major commercial property sectors, industrial REITs comprise 9% of the total global real estate investment universe.1 The fifteen largest industrial REITs in the US currently account for ~$120 billion in market value.2 The publicly listed industrial REITs are largely focused on logistics, owning assets such as warehouses, distribution facilities, and refrigeration/cold storage. Both occupancy and rental rates for these property types were strong heading into 2020. In fact, industrial occupancy ranked the highest among the four major sectors tracked by NAREIT (beating residential, office and retail) at more than 96%.3 Not surprisingly, the industrial sector in the US outperformed the broader REIT sector in each of the last four years and has continued to perform well right up to the market collapse in February.4
There are several reasons for this strong performance. For one thing, e-commerce providers have started competing on the speed of delivery, causing end customers to demand faster deliveries to the home and office. This has created a huge demand for supply chain densification and more sophisticated distribution networks, which in turn require the use of highly efficient and well located industrial assets.5 In addition, the limited supply of high-value distribution and fulfillment centers near large population areas has pushed up occupancy rates and rental rates over the last several years.6 The sector has also benefitted from faster growth than many other property types as more commerce shifts online.7
Understanding logistics. Simply put, the recent growth in the logistics segment of industrial REITs has largely been driven by the increasing need for speed in consumer goods delivery. As a result of the tremendous growth in e-commerce, demand for strategically located logistics assets has outpaced (or roughly matched) supply over the past decade.8 This is reflected in the fact that net absorption has outstripped completions in eight of the last ten calendar years. Not surprisingly, rents have almost doubled since 2015 and climbed another 8% in 2019.9
Stepping back for a minute, the logistics segment can be broken down into a supply chain continuum stretching from producer to end consumer. Once the finished goods leave the producer, they typically pass through gateway distribution facilities (often near airports or seaports), multi-market distribution centers like bulk warehouses, city distribution centers, and eventually last touch facilities like infill warehouses. The commercial properties along this continuum that are located closer to the end consumer have higher relative values per square foot.10 Regulatory constraints, a lack of buildable land, and other barriers to entry help to explain this pricing dynamic. While development has increased significantly over the past five years, it has not been enough to relieve the upward pressure on rents.11
It is not just Amazon, for example, that is making large investments in its e-commerce business and driving demand for logistics properties. Some major brick-and-mortar retailers have adopted an omni-channel approach with success, as evidenced by the major investments made in e-commerce distribution networks.12 Beyond retailers, the tenant roster for industrial REITs also includes some of the largest shipping & logistics providers.13 In other words, the end-users of industrial real estate have become less manufacturing-oriented and more consumer-oriented over the past decade and now account for more than 75% of industrial space demand. This means the sector is more closely linked with consumer spending and retail sales than it has been in the past.14
Industrial REITs in the current crisis. While industrial REITS won’t be immune from the pandemic fallout, the magnitude of the impact on net operating income and asset values remains to be seen. In some ways, we believe industrial REITs are favorably positioned in that they can benefit from an acceleration in e-commerce as consumers increasingly work from home and buying patterns shift from physical retail to no-touch home delivery. In addition, although market rent growth is likely to decelerate because of the pandemic, industry analysts still expect industrial REITs to enjoy potentially faster rent growth than most other property sectors. They also expect robust net operating income growth on the back of in-place rents that are often below market.15 Beyond that, industrial REITs have relatively low maintenance and operating costs compared to many other property types, and tenants generally sign longer-term leases that include annual rent escalators. In addition, certain assets (like highly automated bulk warehouses) could face smaller headwinds from persistent social distancing than other property types like hotels, movie theaters, and casinos.
On the other hand, industrial REITs are generally more sensitive to economic growth than certain other property types such as residential REITS.16 In this regard, a stronger economy typically translates into higher consumer confidence and in turn, higher consumer spending and greater demand for industrial space. The reverse is also true, and it appears that the US and Europe may have just entered a recession.17 Furthermore, a significant portion of e-commerce spending (and logistics demand) comes from brick-and-mortar based retailers. If they weaken significantly, industrial property demand could weaken as well.18 The gateway and bulk warehouse properties could also suffer if the flow of goods from foreign or domestic producers is meaningfully interrupted because of the pandemic. More broadly, landlords are facing (sometimes steep) declines in rent collections along with increased tenant requests for rent forbearance. It is unclear how much this dynamic will impact industrial REITs.
To be clear, there are many uncertainties with respect to the current global health and capital markets hurdles. However, we believe that in any forthcoming market recovery, REITs operating in supply-constrained markets with high-quality assets, healthy balance sheets, and prospects for above-average earnings growth may present an attractive investment opportunity. Furthermore, looking past the current market uncertainty, investors can likely expect structurally lower interest rates around the world, slower economic growth, and new levels of fiscal and monetary stimulus. A slow growth and low-interest rate environment has historically been favorable for commercial real estate and may prove to be so again.
Industrial sector could be a potential bright spot in commercial real estate. Despite the current dislocations in the property market, we believe that industrial REITs could continue to benefit from a host of factors, including the push from e-commerce providers for faster delivery to end customers, tight supply of well-located logistics properties, acceleration in online shopping and growing demand for no-touch home delivery. Once the market turmoil subsides, we believe industrial REITs that own high-value physical assets and have a stable tenant base along with predictable and growing cash flows could present a potentially attractive investment opportunity.
1. Source: Invesco Real Estate based on data from MSCI Quarterly Property Fund Index and FTSE EPRA/Nareit Global Real Estate Index, November 2019.
2. Source: Bloomberg, 4/29/20.
3. Source: Alex Pettee, Hoya Capital Real Estate, Industrial REITs: Not Immune from Contagion, 3/26/20.
4. Source: Alex Pettee, Hoya Capital Real Estate, Industrial REITs: Not Immune from Contagion, 3/26/20.
5. Source: Alex Pettee, Hoya Capital Real Estate, Industrial REITs: Not Immune from Contagion, 3/26/20.
6. Source: Alex Pettee, Hoya Capital Real Estate, Industrial REITs: Not Immune from Contagion, 3/26/20.
7. Source: Alex Pettee, Hoya Capital Real Estate, Industrial REITs: Not Immune from Contagion, 3/26/20.
8. Source: Alex Pettee, Hoya Capital Real Estate, Industrial REITs: Not Immune from Contagion, 3/26/20.
9. Source: Alex Pettee, Hoya Capital Real Estate, Industrial REITs: Not Immune from Contagion, 3/26/20.
10. Source: Alex Pettee, Hoya Capital Real Estate, Industrial REITs: Not Immune from Contagion, 3/26/20.
11. Source: Alex Pettee, Hoya Capital Real Estate, Industrial REITs: Not Immune from Contagion, 3/26/20.
12. Source: Alex Pettee, Hoya Capital Real Estate, Industrial REITs: Not Immune from Contagion, 3/26/20.
13. Source: Alex Pettee, Hoya Capital Real Estate, Industrial REITs: Not Immune from Contagion, 3/26/20.
14. Source: Alex Pettee, Hoya Capital Real Estate, Industrial REITs: Not Immune from Contagion, 3/26/20.
15. Source: Greet Street Advisors, Industrial Sector Update, 3/9/20.
16. Source: Greet Street Advisors, Industrial Sector Update, 3/9/20.
17. Source: Bloomberg, 4/30/20.
18. Source: Alex Pettee, Hoya Capital Real Estate, Industrial REITs: Not Immune from Contagion, 3/26/20.
Blog Header Image: Hannes Egler / Unsplash
NAREIT is The National Association of Real Estate Investment Trusts
Global REITS are represented by FTSE EPRA/NAREIT Global Index is designed to track the performance of listed real estate companies and REITs in both developed and emerging markets
US REITS are represented by FTSE NAREIT All Equity REITs Index is an unmanaged index considered representative of U.S. REITs Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions, there can be no assurance that actual results will not differ materially from expectations. An investment cannot be made into an index.
Manufactured housing is a type of prefabricated housing that is largely assembled in factories and then transported to sites of use.
Investments in real estate related instruments may be affected by economic, legal, or environmental factors that affect property values, rents or occupancies of real estate. Real estate companies, including REITs or similar structures, tend to be small and mid-cap companies and their shares may be more volatile and less liquid.
The opinions expressed are those of the author, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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