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Investment Commentary

Three Tailwinds for Industrial Real Estate

By Jonathan Henshue | Johnson Financial Group • October 07, 2022

3 minute read time

Many investors are casting a wary eye at the rising commercial real estate market and wondering when it will crack. After all, commercial real estate has been one of the few places of refuge this year for investment portfolios. For example, private indices such as the NCREIF ODCE index delivered a strong 12.5% gain through the year's first half. That's in contrast to stocks and bonds, which declined -19.9% and -7.5%, respectively, during the same period.

Investors are rightly concerned about the office sector. Given the growing popularity of remote work, the market for office space is uncertain. However, many people don't realize that the office sector represents a steadily declining percentage of the total commercial real estate universe.

Meanwhile, other property types, like the industrial sector and multi-family housing, are increasing their index representation and have long-term tailwinds. In this commentary, we'll focus on three specific tailwinds backing the industrial and logistics sector. It's now the index's largest component, at 28.6%, and has seen relatively strong performance for the one-year period ended June 30.

Tailwind 1: Shifting consumer preferences

Consumers are increasingly shifting their buying patterns towards e-commerce, a trend accelerated by the pandemic when even those reluctant to buy online were compelled to try the experience. Led by Amazon, consumers have grown accustomed to fast, convenient deliveries and are loyal to companies that can provide that experience.

While total e-commerce activity has steadily grown, it's penetration as a percentage of all purchases in the U.S. still lags behind many other developed economies, suggesting room for continued growth. As a result, vast networks of warehouses are needed across the country for companies to meet consumer expectations, including last-mile distribution centers near major urban centers.

Tailwind 2: "Just-in-case" inventory management

The pandemic highlighted the fragility of a global supply chain that had become accustomed to uninterrupted delivery of the necessary inputs on an as-needed basis, commonly known as just-in-time inventory. When a single item is not where it's supposed to be when needed, every subsequent item in production becomes similarly delayed.

Companies are now aiming to maintain larger inventory levels to avoid future disruptions. This transition from "just-in-time" to "just-in-case" inventory management will require a significant increase in warehouse space.

Tailwind 3: Aging existing supply

A final tailwind is the growing obsolescence of existing warehouse properties across the country. According to CBRE, the average warehouse age in the U.S. is 43 years, with 28% more than 50 years old.

These long-serving warehouses are structurally incapable of meeting the demands of a modern distribution effort. They're smaller, shorter, and unable to handle the heavier loads common today. Newly built warehouses also rely on modern technology such as sensors, automation, and robotics technology to track and manage inventory while increasing productivity. One such example is the growing need for stronger roofs to support solar panels that can charge growing fleets of electric vehicles.

Because most existing warehouses can’t be renovated to meet the demands of modern operations, there is increasing demand for new properties.

Strong fundamentals

These themes have resulted in massive and persistent demand for industrial assets, leading to all-time low vacancy rates as tenants aggressively compete for space. Demand is so strong that tenants are committing to leases for additional space before it's needed, and projects under development are often fully leased before completion.

Although the magnitude of recent industrial-sector performance is unlikely to persist, its long-term outlook remains positive. Accordingly, when it’s appropriate for a client’s financial objectives and risk tolerance, Johnson Financial Group offers access to diversified real estate strategies that provide exposure to industrial properties for client portfolios that include complementary strategies.

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This information is for educational and illustrative purposes only and should not be used or construed as financial advice, an offer to sell, a solicitation, an offer to buy or a recommendation for any security. Opinions expressed herein are as of the date of this report and do not necessarily represent the views of Johnson Financial Group and/or its affiliates. Johnson Financial Group and/or its affiliates may issue reports or have opinions that are inconsistent with this report. Johnson Financial Group and/or its affiliates do not warrant the accuracy or completeness of information contained herein. Such information is subject to change without notice and is not intended to influence your investment decisions. Johnson Financial Group and/or its affiliates do not provide legal or tax advice to clients. You should review your particular circumstances with your independent legal and tax advisors. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your taxes are prepared. Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment losses. Certain investments, like real estate, equity investments and fixed income securities, carry a certain degree of risk and may not be suitable for all investors. An investor could lose all or a substantial amount of his or her investment. Johnson Financial Group is the parent company of Johnson Bank, Johnson Wealth Inc. and Johnson Insurance Services LLC. NOT FDIC INSURED * NO BANK GUARANTEE * MAY LOSE VALUE