Client Portfolio Manager – Global Listed Real Estate, AMP Capital
In 2016, Walmart became a top 10 tenant of industrial REIT Prologis for the very first time in the company’s history, largely as a result of its online sales platform. Clearly, eCommerce is changing the game for industrial real estate, with important implications – and opportunities – for investors.
Demographics, urbanisation, and technology.
We often hear about these global megatrends that are shaping the future of society and indeed, capital markets – but it is perhaps less well known that each one of these trends is investible through an allocation to global listed real estate.
The reason being that real estate – given its very nature as an asset class with intrinsic, functional value – naturally evolves with structural shifts in societal demand patterns.
An informative case study is offered by the rise of eCommerce and its positive implications for the industrial real estate sector.
A quick primer
Industrial is one of the “big three” classes of commercial real estate alongside office and retail. Industrial assets generally include warehouse space, manufacturing facilities, and distribution centres, occasionally complemented by “flex” office space for administration and sales. Typically, these properties are leased to a single user, although can often accommodate multiple tenants, depending on needs.
Industrial assets are characterised by relatively low maintenance capital expenditure requirements and mid to long term leasing structures, generally in the 3 to 5 year range with 10 year leases not uncommon, particularly for specialised space. However, industrial assets tend to have short construction periods of 6 to 12 months, meaning that developers can respond quickly to upticks in demand and the risk of new supply is ever-present and must be monitored closely.
The demand drivers of industrial real estate include trade volumes, retail sales, inventories, industrial production and manufacturing. As such, it is often viewed as an attractive bricks-and-mortar play on the economy. In recent years, the rise of eCommerce has added a meaningful long term demand pillar in support of the industrial real estate sector.
Clicks to knocks
In the US, eCommerce sales have grown at around 15% per annum for the last five years as pure-play online vendors have expanded market share and traditional retailers have supplemented in-store sales with an online platform. As of 2015, conservative estimates suggest that eCommerce represents around 7% or US$350 billion of total US retail sales, which is predicted to reach 9% or US$490 billion by 2018 (Source: MWPVL International, 2016).
The implication for industrial real estate is two-fold. Firstly, as eCommerce grows its share of the overall retail spend, it becomes an ever larger and increasingly important demand driver for the sector. To put this demand in context, it is estimated that in the US, eCommerce-related demand has accounted for one third of all new warehouse leases over 500,000 square feet since 2010 (Source: Green Street Advisors, 2016). The demand is not necessarily confined only to the pure-play eCommerce behemoths such as Amazon, but also the traditional retailers diversifying their sales channels – notably, Walmart has seen eCommerce sales growth of around 20% per annum over the past five years (Source: Green Street Advisors, 2016).
Secondly, the aforementioned eCommerce-related demand is often composed of very unique and specific requirements as it pertains to the real estate assets themselves. The supply chains of online and traditional retailers are, unsurprisingly, markedly different:
The focus of eCommerce tenants on order fulfilment – or “e-fulfilment” – brings with it a much greater emphasis on speed of through-put over storage. This translates into demand for a specific type of asset; namely, closer proximity to population centres and shipping hubs, larger overall square footage (500,000 plus), larger bay sizes, high ceilings, and more parking space.
- Location matters because the value proposition centres on speed of delivery – the so-called “click to knock” timeframe.
- Size matters because eCommerce tenants require a disproportionate amount of space, due to the variety of goods and the more individualised (and thus inefficient) packaging.
- Clearance height matters because eCommerce tenants typically require multiple levels of storage.
- Parking matters because of the higher ratio of staff required for e-fulfilment hubs versus traditional warehouse space.
And now for the final kicker: given these requirements, most US industrial real estate built prior to 2000 is functionally obsolete for today’s eCommerce tenants.
What does this mean for investors?
Clearly, the rise of eCommerce has begun to revolutionise industrial real estate. Over the property cycle, industrial landlords should therefore be in a stronger position to push rents, given the expanded demand base supporting the sector.
The industrial REITs with exposure to large, contemporary, distribution centre-type assets in high barrier markets, overseen by quality management teams with insight into the needs of eCommerce tenants, will be best placed to deliver value in response to this structural shift.
Investors should therefore consider dedicated listed real estate managers with specialist expertise and on-the-ground coverage of industrial markets in order to unlock access to this and other market-defining trends of today.
The AMP Capital Global Listed Real Estate team has several upcoming whitepapers related to this topic. AMP Capital’s Head of North American Listed Real Estate, Joe Pavnica, will be analysing the future of the mall against the backdrop of the growth in eCommerce, whilst Dominic Cappellania (Chicago-based Analyst / Portfolio Manager), will delve further into the relationship between eCommerce and industrial real estate in the United States.
Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.