Industrial real estate has been on a great run with no sign of slowing down.
COVID-19 has disrupted the entire economy, although much of the disruption is an acceleration of existing trends rather than anything new. Changes in retail buying habits, office design, and residential preferences are unlikely to fully settle out for a while.
However, the industrial real estate market sector is still doing well. For example, Link closed $1.9 billion in acquisitions and sold $900 million in dispositions in 2020. With the rest of the economy in the doldrums, why is industrial property still doing reasonably well, and what does this mean for after the pandemic?
E-Commerce is Booming
The pandemic has greatly accelerated the existing shift from brick and mortar retail to e-commerce, with sales rising 28% in June 2020 compared to June 2019. While it’s very likely that this trend will partially reverse when the pandemic winds down, as many consumers miss the experience of browsing in retail stores, others may have abandoned the mall forever.
This is resulting in an increased demand for warehousing and fulfillment centers – prime examples of industrial real estate. Some retailers have converted underperforming stores to fulfillment centers, either permanently or temporarily, whilst others are looking to redesign stores to serve both purposes. Amazon has purchased 25 million square feet of warehouse space in 2020, adding employees and potentially driving rent growth. Also, as more people order groceries online, there is a demand for temperature-controlled warehouse space for food storage. How much this trend will reduce in late 2021 and into 2022 is unclear, but projected compound growth through 2025 is about 12.1%.
Reshoring is Happening
The pandemic, combined with increased tariffs, has shown many companies just how vulnerable global supply chains are. Nearly two-thirds of North American manufacturers want to bring at least some of their production and sourcing back to the continent and are engaging with the industrial real estate market. This should increase the demand for industrial space as well as improving the job market. Manufacturers may also be looking at space that is better designed to avoid crowding of employees.
Supply chains are based off of cost, and things are moving in such a way as to make reshoring profitable. This will result in an increase in demand for industrial space of all sizes, including in traditional industrial centers which have recently been struggling.
Office Space Will Still Be Needed
Some companies are indeed moving towards a permanent remote workforce. However, the market does not show this as a trend solid enough to affect the demand for office space. A survey done in May, 2020, indicated that only 12% of U.S. workers want to work from home full time. As temporary work from home extends into 2021, trends may change, but many workers (and supervisors) are likely to look forward to returning to the office even more.
However, the pandemic has highlighted the known problems with cubicle farms and open plan offices, and new buildings and refits are likely to move towards alternatives. For example, W4 in Austin, Texas, is designed to allow offices that include outdoor space and avoid shared amenities whilst providing easy access to an outdoor mall. Cubicles and open plans are replaced with pods that allow a smaller number of people to work together and collaborate. With more workers working part time from home and/or seeking flexible hours, time sharing of enclosed offices is likely to become more of a thing.
There’s also an increased demand for high level ventilation systems, touchless doors and toilets, and indoor-outdoor workspaces. Some designers are considering increasing the number of elevators and there’s a chance that the pandemic will reverse the trend of rendering stairwells unusable except in emergencies.
“Just in Time” is Under Review
In spring of 2020, consumer shortages hit the news. It wasn’t just the now infamous toilet paper. In affluent neighborhoods where people typically ate out a lot, there were often shortages of meat and flour as supermarkets simply did not carry enough inventory to meet the sudden demand from people who were cooking more of their own food. Back in 2006, the Wall Street Journal said that just-in-time inventories would make us vulnerable in a pandemic, and while they were primarily talking about medications, it’s clear that they were on to something. In fact, COVID-19 did indeed trigger shortages of certain drugs, including hydroxychloroquine and chloroquine, falsely touted as treatments for COVID-19, but also including shortages of anesthesia drugs, some antibiotics, and hydrocortisone.
Manufacturers and vendors are now considering whether just-in-time inventory is, in fact, a good idea. The move to a more balanced approach with larger stockpiles is also going to increase the demand for warehouse and fulfillment space.
New Uses for Vacant Properties
All of these changes are also supporting a push towards conversion of properties to new uses. One type of property that is particularly affected is the shopping mall. Underperforming malls are being demolished or converted to new uses. For example, a struggling mall in Northern Virginia has been purchased by Inova for conversion to a new medical campus; this is a perfect use for underperforming suburban malls due to the high demand for parking at medical facilities.
Empty big box stores are being converted, as already mentioned, into distribution centers. While there will continue to be demand for traditional retail, the fact is that the world is changing. Another use for these sites is ghost kitchens, which benefit from being placed in clusters and need to be close to residential neighborhoods. The ghost kitchen phenomenon is likely to grow. Finally, although mostly out of the scope of this article, some malls are being converted to workforce housing, that is to say housing that falls between affordable housing and luxury and is aimed at middle class professionals such as teachers and police.
Life Sciences Demand May Continue
The desperate quest for vaccines and treatments for COVID-19 caused a surge in demand for lab spaces, including conversions from office buildings, in 2020. Reshoring has also been key here. But even after the pandemic, it’s likely that there will be an increased demand for highly-specialized buildings designed for life science research. Personalized medicine, for example, may increase the demand for smaller labs that do small batch work on, for example, cancer treatment, and for companies to move away from one centralized research location to a bunch of smaller ones located closer to residential areas.
The fact is that the pandemic has only shifted industrial real estate market property demand, but not significantly reduced it. It has also highlighted existing trends and developers should consider the likelihood for continued increase in the areas of warehousing for fulfillment, small scale production (especially in the life sciences) and mall conversions as the world moves forward.
Essel specializes in helping industrial property developers manage environmental risk. We can guide you through the challenges and opportunities that come with acquiring properties in the industrial real estate space.