Omni-Channel Retail’s Omnivorous Hunger for Industrial Space

By Alice Chung, Analyst, Moody's Investors Service: Despite capital markets volatility, industrial REITs continue to benefit from steady growth in online sales.

Alice ChungDespite volatility in the capital markets and uncertainty about the state of the global economy, logistics real estate fundamentals continued to strengthen in the first half of 2016, driven by a rise in e-commerce. As a result, the supply-chain model has been forced to adapt quickly, making industrial REITs one of the biggest benefactors of this ongoing trend.

The rapid shift to e-commerce shopping is a key growth driver for the industrial property sector and plays a significant role in creating demand for industrial warehouses. Well-located distribution centers are critical in fulfilling orders, especially as consumer behavior has evolved into a “need-it-now” lifestyle.

Retail e-commerce sales totaled $87.5 billion in the fourth quarter of 2015, a 16 percent annual growth rate, according to the Census Bureau. U.S. e-commerce retail sales are projected to reach $306 billion this year and have been averaging gains of 10 percent annually throughout much of the past decade, with the strongest growth in the last several years. As Moody’s has stated in previous research, U.S. online retail sales are averaging 7 to 8 percent of total retail sales and could potentially achieve a double-digit share of the total in about three years.

Adding to this demand for industrial space is the pressure that Amazon puts on traditional retailers and other online competitors. The shipping game is constantly being redefined by this retail giant. It first began with two-day shipping, followed by next-day and now same-day shipment in 23 metro areas. This poses a huge challenge for traditional retailers, because where Amazon goes, other retailers must follow. Now more than ever, brick-and-mortar stores are focused on proximity to customers, otherwise known as “the last mile,” leading to a surge in demand for big-box facilities as well as smaller, infill warehouses.

The increase in new construction of state-of-the-art mega-distribution warehouses—facilities of more than 300,000 square feet, with 30-foot ceilings or higher—has quadrupled over the last four years. Demand for modern Class A facilities continues to be strong, especially in West Coast markets, where big-box vacancy rates are trending below 5 percent.

Rental rates should grow during 2016 in the 2 to 4 percent range, and demand has exceeded supply for 24 consecutive quarters, driving industrial vacancies down to 5.6 percent in first quarter 2016.

While industrial REITs continue their path toward improved profitability and higher revenues, we do see potential risks, ranging from the impact of rising interest rates (largely dependent on how far and fast rates rise when they do) and concerns of supply built on a speculative basis in select markets where tenant demand is slowing.