Triumph News

Yes, of course the risk profile of distribution warehouse properties has changed in 2020, just like everything else in the world. At the same time, I think it’s fair to say that it has changed to a lesser degree than most other asset classes. The question is: What does it look like now, and are the changes permanent? The paths of so-called mid-market assets of less than 500,000 square feet and those of 500,000 sf to more than 1 million sf diverged sharply in mid-March, specifically pertaining to vacancy/leasing risk. Thanks to the e-commerce surge that coincided with the initial coronavirus surge, the biggest e-retailers, especially Amazon, did not skip a beat in their absorption of fulfillment space and large regional distribution centers. In fact, in some of our U.S. markets, Amazon by itself represented upward of 80% of all net absorption in the second quarter, almost exclusively by way of leasing buildings above 1 million sf. The reason for this is that one lesson learned from coronavirus by the larger retailers is that surges in e-commerce create inventory management problems and, in response, they began turning from “just-in-time” supply chain models to new “just-in-case” inventory levels.

Meanwhile, smaller retailers and manufacturers hit the leasing snooze button, repeatedly, due to overall economic uncertainty. Among the sub-500,000-sf logistics-user crowd, we saw expiring third-party logistics contracts being renewed month to month rather than the typical one- to five-year terms, a number of smaller retailers suffering from severe supply disruptions related to Chinese manufacturing dependence, and domestic manufacturers cutting labor hours and output.

As a result, companies with expiring leases were only willing to extend leases for short terms and seeking to satisfy new capacity needs with short-term leases. In fact, we saw a lot of demand for lease terms ranging from month-to-month through six-months, with the occasional one-year term, and noted that some users were turning increasingly to temporary capacity (warehouse as a solution) providers like Flexe, Warehouse Exchange and others.

These tendencies have stretched out vacancy time for mid-market distribution and even last-mile spaces, while keeping solid overall absorption statistics in play thanks to the appetites of the biggest retailers. Vacancy risk increased as projected downtime became more difficult to predict. The possibility of downward pressure on rents for smaller spaces also entered the equation for the first time in a long time. In fact, we hit the snooze button on our mid-market speculative development projects in order to ensure delivery after a vaccine becomes widely available and herd immunity begins to take hold, perhaps late 2021 or early 2022.

On the other hand, vacancy risk related to 500,000-plus-sf facilities narrowed, as the leasing of speculative developments sustained hardly a hiccup.

Naturally, capital markets transactions followed the risk profile closely. After a two-month period from April to May during which virtually no new acquisition opportunities came to market, deal flow began to trickle out again in June, led largely by ultra-low-risk, long-term, single tenant net-leased assets. As summer pushed on and we experienced a second wave of the virus, STNLs were joined in the marketplace by sellers who had aggregated, sometimes disparate, portfolios into institutional sizes, usually well north of $50 million. Through this time, there remained a dearth of one-off, sub-$50 million projects, but those finally began to emerge in October, roughly about the same time as institutional capital allocations for 2020 became exhausted.

Among these smaller projects, we also began to see a few offerings with some leasing risk – the “value-add” acquisition type – but, of course, these assets need a price discovery period as the virus and its current third wave remains with us for at least the next few months.

Underwriting lease-up time on value-add projects is scarcely more reliable than it was in the spring, meaning not very predictable at all.

Economic risk remains the most difficult to forecast, because of the enormous, unprecedented variables of both capricious government mandated economic restrictions and erratic political direction on fiscal stimulus. Predicting the direction of the economy using data, like the good old days, is so subordinate to these variables that it is somewhat pointless. Well, here we go anyway: The economy rebounded smartly from the shutdowns and gross domestic product grew 33.1% in the third quarter following its -31.4% cliff dive in the second, which looks rather like a “V” shape when graphed, but this is not the case for the labor market, which took on the swoosh. Huge gains were made early in job recovery, but it then leveled off and stayed there, with unemployment likely to end the year hovering around 7%.

Absent government restrictions/ stimulus, we should expect growth to continue but more slowly as long-term unemployment begins to weigh on consumer spending. Even with herd immunity, it will take many quarters of growth to restore employment levels to their history making pre-pandemic levels.

Ultimately, recovery will continue through 2021, allowing logistics real estate to equalize across all size ranges, likely within the next 12 to 18 months, thus validating its new era status as the overall most risk averse asset class in commercial real estate.