Forget your fancy office towers. The future lies in warehouses.
But not just any old dusty depot. It’s got to be big enough, smart enough and close enough to consumers. Pick right and you could beat the returns of every other kind of property this year.
Real estate investment trusts that specialize in industrial properties, such as Prologis Inc., Rexford Industrial Realty Inc. and Terreno Realty Corp., are outperforming REITs that focus on malls, residential rentals and office buildings. The three companies all returned more than 16 percent in the past year, crushing other types of real estate — and handily beating their own peers in the Bloomberg REIT Industrial/Warehouse index, which reaped 8.3 percent.
It’s all about e-commerce. Online shopping still accounts for less than 10 percent of retail sales in the U.S. but is reconfiguring supply chains and shaping the fortunes of warehouse landlords. Demand is especially keen in and around big cities, where online shopping has caught on fastest.
Those are the same places — New York, Boston, Chicago, San Francisco, Los Angeles — where land parcels big enough for the latest warehouses and loading docks are scarcest, and rents are highest. Online retailers require about three times the warehouse space of traditional brick-and-mortar stores, and more-sophisticated logistical services.
“E-commerce has taken a business that was already pretty solid and turbocharged it,” Prologis Chief Executive Officer Hamid Moghadam said in an interview. Among other differences, he said, “in a regular warehouse that supplies a retail store, you are dealing with pallets of goods that are moved around. In the case of e-commerce, there is a lot of packing and handling.”
Consider the 12-month return of the biggest U.S. mall owner, Simon Property Group Inc., at negative 9.7 percent, and the BBG Office Property REIT Index, at negative 11.7 percent. The two biggest apartment owners in the U.S. by market capitalization — Equity Residential and AvalonBay Communities Inc. — respectively returned 0.35 percent and negative 8.5 percent in the past year.
Picking the Winners
Which industrial REITs win and which fall victim to the next economic downturn will depend partly on proximity to major population centers. “There was an old name for the last mile — it was called retail,” Moghadam said. “Instead of the facility being the last mile to your house, you were a mile from the retail store.”
The Terreno REIT, which is in six U.S. markets, and Rexford, focused on Southern California, are best positioned to increase rents, said John Guinee, an analyst at Stifel Nicolaus & Co., while Liberty Property Trust and First Industrial Realty Trust Inc. are more “susceptible to a slowdown in the economy.” Prologis, which like DCT Industrial Trust Inc. and Duke Realty Corp. has a national presence, can use its financial might to pick its spots, he noted.
At Prologis, the biggest industrial REIT, e-commerce accounts for about 10 percent of revenue, 20 percent of new leases and close to 30 percent of new developments, according to the company. The dearth of land available for development in New York City prompted Prologis to snap up a 200,000-square-foot (19,000-square-meter) warehouse in the Bronx last year. It’s also the reason the company is building a multistory facility of almost 600,000 square feet in Seattle, a first in the U.S. because it’s hard to maneuver tractor-trailers above ground level.
“Multistory is very expensive” to build, said Bloomberg Intelligence analyst Lindsay Dutch. “Prologis is in a position to take these risks and do these projects. They’ve done it in Asia, with ramps for the trucks to the second floor, but the third floor is elevator access only, so you can’t charge as much for that.”
The high cost of land and construction in major urban centers like New York and Los Angeles has helped save industrial landlords from the mistakes common to office, retail and residential developers — overbuilding when demand is high, which forces rents down when it declines.
“Commercial real estate is all about supply and demand, and industrial supply has been very disciplined,” said Ross Smotrich, an analyst at Barclays Capital Inc. in New York.
Whether the warehouse REITs sustain that discipline is another matter.
“Industrial is anywhere from a 5,000-square-foot building in Manhattan to a million square feet in suburban Indianapolis,” Guinee said. Outside the big urban centers, he said, “clearly some markets are in the process of being overbuilt, and those will suffer more when the inevitable recession comes.”