The industrial sector has been on a tear for the last five years or so. What began as an asset class primarily sought after by life insurance companies is now very much the darling of Wall Street and Main Street alike. The amount of capital currently chasing the asset class is immense, and it is applying downward pressure on yields. Furthermore, the asset class is buoyed by incredibly strong tailwinds from the once gradual, but now tectonic shift to e-commerce. While much of this may be old news, the market is beginning to see a few new trends emerge. These trends are having an immediate impact on today’s industrial market and are likely to influence the sector for years to come.
One new trend we’ve seen is an influx of New York City family offices chasing industrial product, particularly in the Southeast region. They are diversifying out of their New York City multifamily portfolios, which have been beleaguered by 2019 rent regulations and 2020’s pandemic. Demand from this investor group is expected to rise, and with growing populations in the Southeast, these buyers should see an increase in available industrial investment properties in future years.
Annual Sales Volume & Year-End Cap Rates
Source: Stan Johnson Company Research, Real Capital Analytics; analysis includes sales greater than $2.5m
A shift in geographic growth patterns is a second trend we’ve been watching closely, especially during the pandemic. For years, people have been moving to growth markets in the Southeast, Texas and the West, among others. Markets such as Tampa, Orlando, Jacksonville, Greenville/Spartanburg, Charlotte, Raleigh-Durham, Dallas, Austin, Denver and Salt Lake City have been booming. That was pre-pandemic though. Before COVID-19 hit, towns like these were offering great jobs and a lower cost of living than the larger metros. Now, the pandemic has enabled remote work on a much greater scale than in the past, so the job dynamic doesn’t necessarily need to be in play. We’re now beginning to see smaller towns like Missoula, Montana – with a population of only 120,000 – or resort towns like Park City, Utah start to see an influx of population growth. These markets will need more industrial space as populations start to rise, and that will create new opportunities for investors.
A third emerging trend is institutional capital’s willingness to buy smaller deals in the $5.0 to $20.0 million range. This shift in institutional activity is putting downward pressure on yields in traditionally high-yielding assets. Yesterday’s 7.0 percent cap rate is today’s 6.0 percent cap rate. With the assumption of increased deal volume, continued low interest rates, and an abundance of capital chasing scarce deals, it is possible the market could see another 50 basis points of cap rate compression – perhaps not across the entire sector, but certainly for the highest quality assets including Class A distribution facilities.
A final trend to watch is institutional activity in the second-generation subset in secondary markets. These include smaller deals, Class B or C construction, non-credit tenants and/or short-term leases. While this used to be a place to find yield – as high as an 8.0-percent cap rate – institutions are now starting to enter this space, and that’s impacting cap rates too. In 2021, it is possible we will see 6.75 percent cap rates on assets that would have been trading 100 basis points higher in the past.
The industrial market ended 2020 on a very high note, and we expect deal volume to stay very strong in 2021. However, we will continue watching these and other emerging trends to see what additional impact there will be on the sector and what new opportunities will be created for industrial-focused investors.