Steady During Pandemic

May 3, 2021

As the COVID-19 pandemic continues to disrupt commercial office space usage and brick & mortar retail sales, the industrial sector has been a bright spot in commercial real estate in 2020. As many Americans work from home, avoid restaurants and shop online, the industrial sector has been buoyed by e-commerce companies’ demand for distribution and logistical facilities.

According to the Costar Third Quarter Industrial Report, leasing activity hit a record high in the third quarter, up 30% from any previous quarter with Amazon accounting for 10% of the total leasing volume since March. Other retailers such as Target, Walmart and Home Depot have also expanded their warehouse and distribution footprints. Demand for industrial space has also been driven by companies wanting to store up inventory as the pandemic revealed vulnerabilities in global and national supply chain networks. Although manufacturing companies have experienced a more mixed impact from the pandemic given a drop in demand for discretionary goods and construction materials, according to Costar several major manufacturers including Komatsu, Leonardo DRS, Milwaukee Tool and General Motors have all signed leases in the third quarter.

While the overall performance of the industrial sector has remained steady, there is a downside as new supply has led to negative absorption, slightly higher vacancy rates, and lower asking rents. This national trend is also reflected local industrial leasing activity in the third quarter. According to Greenleaf’s third-quarter data, 51,175 square feet were delivered to the market with overall negative absorption of 67,482 square feet in the third quarter. Although still at the second lowest level over the past three years, local vacancy rates ticked up to 2.21% from 1.85% at the end of the second quarter. With more local supply available for lease, asking rents went down slightly to $6.74 from $6.79 at the end of the second quarter.

Industrial commercial real estate remains a solid investment choice for investors looking to avoid the risks associated with office and retail properties. Although industrial sector asset valuations are up 7.4% in September compared to the same time last year, according to Real Capital Analytics, Costar forecasts that “investors and lenders will be carefully evaluating future cash flows, rent growth, and occupancy as the recession unfolds. Higher risk spreads translate into higher cap rates, which will cause an interruption in price gains this year. After that, rent growth will help to support positive price gains that could rise 2%-3% per year”. Locally, industrial market cap rates are likely to remain around 7% with valuations holding steady as flat rent growth is offset by investor demand.

As analysts expect that economic activity will return to its pre-pandemic level by mid-2021 with the delivery of vaccines and improved therapeutics, hopes are high that commercial real estate activity will improve across all use types by the second half of 2021. Nonetheless, the industrial sector is anticipated to be the best-performing commercial real estate asset through at least 2021.