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E-Commerce Demand Shifting Construction from Retail to Logistics, Boosts Absorption to Near-Record Levels

More Investors Pursue Higher Yields by Backing New Development as Industrial Real Estate Expansion Rolls On
November 3, 2016
The appetite of internet-based sellers and other retailers for newly built logistics properties drove net absorption of industrial real estate to its highest total since early 2000 during the third quarter.

In addition, e-commerce demand appears to be taking a bite out of the retail construction and shifting it to the logisitics sector. The 53 million square feet of new logistics space delivered by developers in the third quarter was the second-highest quarter on record.

The large amount of new supply kept in balance with strong demand as logistics tenants absorbed 56 million square feet of warehouse and distribution buildings, according to CoStar's recent Third Quarter 2016 Industrial Real Estate Review and Forecast.

Strong leasing and absorption of logistics buildings pushed the U.S. logistics vacancy rate down to 7.1%, lower than at any point during the past two real estate market cycles, while year-over-year rent growth remained off the charts at 7.1% and 6.4%, for light industrial and 6.4% for logistics assets, respectively.

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Even by the projected end of the current cycle in 2020, CoStar forecasts that the logistics vacancy rate in the 54 largest U.S. markets will rise only to 8.5%, nowhere near its 10.4% average since 2000, noted CoStar Portfolio Strategy's Shaw Lupton.

Despite strong demand and sustained rent growth, rising levels of new construction paired with the gradually tightening availability of construction financing is beginning to put pressure on vacancies in a growing number of markets as the expansion phase of the logistics market starts to wind down. Thirty of the top 54 U.S. markets posted declining occupancy and rising rents in the third quarter, the most of any major property type.

The demand and absorption drivers for logistics space remain solid. Retail inventories relative to sales are at their highest levels since 2009 as Amazon.com and other e-commerce operations locate their inventories closer to population centers in the effort to speed goods to the consumer at ever increasing rates.

While investment sales are down across the board in 2016, sales volume is down only 6% in the industrial sector, the lowest among the four major property types, with fewer trades of large portfolios than last year and more investment capital being re-allocated from purchases of existing property to new development. Last year's record sales volume included such huge portfolio buys as GLP's $8 billion purchase of Blackstone's IndCor portfolio in February 2015, and GLP's $4.55 billion acquisition of Denver-based Industrial Income Trust's 58 million-square-foot portfolio a few months later.

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Investors are also finding higher yields in building new assets as per-square-foot prices for existing buildings rise above their historical average in many large markets.

"To some people’s shock in the industrial sector, some of the money that ordinarily would have gone to buying properties is now going into construction because investors can now make higher going-in yields once the building stabilizes, compared with buying a stabilized property," observed Rene Circ, CoStar's director of research, industrial.

As a result, merchant construction, which historically has tended to constitute about 25% of total trading activity, fell to around 10% between 2012 and 2015. While merchant building contributed more toward total sales volume in earlier cycles as they sold their newly developed buildings, balance sheet developers like Prologis (NYSE:PLD) and other industrial REITs have held onto rather than trading their new properties.

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