Buyers Crowd Texas Industrial Markets
By Taylor Williams
E-commerce has revealed some fundamental truths about how humans consume goods, mainly that price point and convenience are by far the most important criteria in purchase decisions.
The COVID-19 pandemic has served to further ingrain these mentalities and to suck more people into the world of online shopping in the name of adhering to public health guidelines.
According to the U.S. Census Bureau, in 2020, a year in which a global health crisis spurred furious increases in online shopping, total e-commerce sales clocked in at $791.7 billion, up a staggering 32.4 percent from 2019. E-commerce sales accounted for 14.4 percent of all retail sales in 2020 — essentially double the 7.3 percent proportion in 2015.
In addition, the National Retail Federation (NRF) is projecting that e-commerce sales will grow by 18 to 23 percent in 2021, yielding a total annual sales volume in excess of $1.1 trillion. Based on 2020 figures provided by the NRF, which cited total retail sales of just over $4 trillion, the e-commerce component is now poised to account for more than a quarter of the market.
Especially in the early days of the pandemic, the need to minimize shopping trips and shelter in place was a big driver of elevated e-commerce activity. But the rub is that because of COVID-19, new types of consumers have jumped aboard the e-commerce train.
“The pandemic took that basic appeal of e-commerce and targeted it to an older audience who didn’t traditionally shop that way,” says Alfredo Gutierrez, founder and president of Houston-based investment firm SparrowHawk Real Estate Strategists. “Those people represent the wealthiest demographic in the country and need convenience. They were forced into e-commerce, but they’ve since realized how easy and convenient it is and how it tailors to their needs.”
For those reasons, many who spent most of their lives patronizing brick-and-mortar retail may not be going back to the old ways of shopping, Gutierrez adds. Elevated e-commerce activity is pushing development and absorption to new heights, generating higher valuations and investment interest in industrial properties.
As a result of these factors, the age-old rationales that once discouraged investment in industrial real estate — shareholders don’t find it sexy, manufacturing is moving overseas, the returns are too low — are relics of a different era. And given how the pandemic has exposed the vulnerabilities of other asset classes, industrial real estate is the proverbial pie that every investor wants a piece of.
Demand for these industrial assets is even more pronounced in high-growth markets, of which Texas has several. As tenant demand for industrial space continues to grow, prospective buyers face record prices and levels of competition.
According to a recent report from JLL, the average price per square foot across all classes of industrial properties in the United States rose by 53 percent between 2013 and 2020. Price gains and cap rate compression have been even stronger for infill multi-use logistics facilities, such as those favored by e-commerce users, the report found.
Spreads between bid/ask prices have tightened significantly. But in 2019 and even in 2020, sellers were able to command their own pricing,” says Gutierrez. “Cap rates have compressed over the last year, so it’s not so much about the spread since sellers are getting their prices at these lower cap rates. Real estate in general is a good investment and is now a desired component of just about every major investor’s portfolio.”
But despite the high price of admission in the industrial investment space, capital sources of all types are ready to play ball, mainly because they believe the game is really just getting started.
“The fundamental indicators for continued growth in industrial are visible in many markets,” says Sean Dalfen, president and CEO of Dallas-based investment and development firm Dalfen Industrial. “We’re still in the early innings of e-commerce in terms of what percentage of total retail sales it represents, and we can’t see that percentage going down because e-commerce is so convenient.”
If the need for retailers to develop robust online sales platforms and omnichannel distribution systems wasn’t painfully obvious before last spring, it certainly is now. If retailers don’t invest in these capabilities, they’re sunk, so ponying up for rising industrial rents is a necessary cost of doing business, Dalfen says.
“Let’s say you’re a retailer that historically operated in brick-and-mortar settings, which aren’t going away but are declining substantially,” Dalfen theorizes. “If your retail rent was $25 per square foot, are you really going to care if your industrial rent is $9 [per square foot] this year after being $5 last year? You’re out of business if you don’t invest in your e-commerce platform.”
With household names like Amazon, Walmart, Target and Best Buy leading the charge in terms of large-scale leasing and development, the perception of industrial properties as desirable investment vehicles is gaining traction — and not just within real estate circles.
“With the growth of Amazon and e-commerce, industrial real estate is now part of the conversation on Wall Street and in people’s homes,” says Gutierrez. “Buyers that traditionally didn’t want to be in industrial are now coming into the market, and it’s putting pressure on pricing.”
Gutierrez adds that these new buyers run the gamut of investor profiles. From institutional investors that are divesting of retail or office assets to high-net-worth individuals to family funds that are able to raise significant amounts of capital, every type of buyer is represented on some level. That pool also includes sources of foreign investors, which Gutierrez says are often raising capital through crowdfunding mechanisms.
Location is Everything
With so much capital targeting the space, owners of older industrial buildings in Texas are incentivized to rehabilitate their properties and subsequently market them for sale, says Huntley Luna, vice president of the industrial division at Dallas-based Henry S. Miller Brokerage.
“In DFW, lease rates and purchase prices are definitely creeping up for second-generation industrial space because there aren’t a lot of properties for lease or sale,” he says. “Each submarket has its own flavor and hotspots in terms of the focus on building aesthetics and functionality. But every user needs a warehouse, and there’s a lot of activity in making functionally obsolete buildings more appealing to tenants.”
In March, a partnership between Dallas-based CanTex Capital and New York City-based Imperium Capital purchased a 19.2-acre industrial site at 4001 Irving Blvd. within the Interstate 635 loop. Though the site currently houses some 135,000 square feet of existing buildings, the partnership recognized the rare opportunity to acquire an infill site of that size with long-term redevelopment potential
Luna notes that the move to rehabilitate and modernize older industrial product is strongest in submarkets that offer robust labor supplies. When considering deals for second-generation properties, in some cases, investors would rather pay more to acquire a building in a strong labor market.
Given that many of the firms that are taking down space have highly specific workforce needs, such as qualified truck drivers, it comes as little surprise that labor continues to play a critical role in site selection for both tenants and investors.
While automation is an oft-broached subject within the conversation of industrial labor, Dalfen says that even with the advances in artificial intelligence (AI), the nature of e-commerce at this point in time is so human-intensive that labor remains a top focal point for these users.
“Irrespective of automation, having proximity to those who work at the facility and those who buy the goods coming out of the facility is still critical for every e-commerce user,” he says. “Over an extended period of time you’ll see more automation, but if you’re close to people, it doesn’t matter how you deliver so long as you’re fast and efficient. That’s what’s going to attract tenants — the location.”
Trends within e-commerce, such as how returned items are handled, continue to influence moves for industrial users that provide transportation and logistics services, Luna says.
“Approximately 30 percent of all goods that are purchased on Amazon are returned to secondary facilities,” he points out. “And there’s so much demand for the transportation businesses that support those facilities and that reverse supply chain. You really can’t find a lot of product to support these users in the metroplex, and what you can find is expensive and going up.”
As an example of a deal that supports the reverse supply chain, Henry S. Miller recently brokered the sale of a 14.6-acre tract at 34980 LBJ Freeway in Dallas for the development of a 15,540-square-foot facility for OTR Fleet Service, which provides maintenance services for commercial vehicles. The firm’s development division is also leading construction of this project.
Even in the face of a global health crisis and recovery, the fundamental factors of job and population growth that drive development, absorption and pricing of industrial product in Texas have barely skipped a beat.
The state’s rate of population growth slowed in 2020, but still remained positive, expanding by 1.29 percent year-over-year. With more than 29 million residents, Texas is now poised to gain two additional congressional seats as a result of its torrid population growth.
In addition, perhaps the most high-profile corporate announcement of the year came in December, prior to the COVID-19 vaccine rollout, when Oracle revealed its plans to relocate its headquarters from Silicon Valley to Austin.
But beyond the Texas borders, multiple macro-economic factors that could slow price appreciation for industrial assets may be brewing.
For starters, the national economy is almost certainly headed for a period of inflation. With trillions in stimulus and relief payments having been pumped into the system over the last 15 months, the simple fact is that the U.S. dollar soon won’t buy what it used to, as currently evidenced by rising food and gas prices.
In addition, with the federal funds rate still hovers between 0 and 0.25 percent to stimulate growth amid the recession. While interest rate hikes would serve as a hedge against inflation, they would also translate to a more expensive cost of capital for borrowers. The Federal Reserve convened on Wednesday, April 28, and hinted at an awareness of a strengthening economy that would likely necessitate rate hikes before the year is through.
But even if devalued dollars come down the pike, sources believe that demand for industrial space is still strong enough to offset the effects of inflation.
“If cap rates start to rise, rents are still growing fast enough to cover that movement and for the investment to still be profitable,” says Gutierrez. “We see that now with the 10-year Treasury yield moving up, and the spreads there are compressing as they return to historical levels.”
— This article originally appeared in the April issue of Texas Real Estate Business magazine.