Owners of Data Centers and Industrial Space Could Emerge Stronger From Crisis, Analysts Say
While economic forecasts vary and broad uncertainty lingers, some sectors of commercial real estate may emerge from the coronavirus crisis stronger than before.
E-commerce-related industrial space and data centers could come out ahead if social distancing changes consumer and work-from-home habits in the long term, said Kevin Thorpe, chief economist at brokerage Cushman & Wakefield, in a March 23 webinar.
“Industrial, logistics, warehouse [were] booming before going into this crisis and may come out of this stronger than ever, even if there are some short-term headwinds in terms of a drop in consumption that is expected and supply chain distribution,” Thorpe said. “There is also this longer-term shift in e-commerce just out of necessity and that may induce some longer lasting behaviors in consumers.”
The analysis echoes similar observations from analysts at JLL and CBRE in recent weeks. They point to potential long-term growth for the industrial property sector despite short-term challenges in supply chain disruptions, international trade tensions and reduced activity at ports and warehouse. Abby Corbett, CoStar's managing director and senior economist for the industrial space market, notes that crises like the current pandemic reinforce the value of data centers, not just as critical cogs in the internet machinery, but because they require "very little in the way of on-site employees."
CBRE analysts said in a webinar last week to expect a short-term drop in leasing activity in the industrial sector as tenants take a “wait and see” approach. CBRE expects long-term demand to grow with continued strength in last-mile, cold storage and e-commerce properties.
JLL analysts said the outbreak initially will likely result in falling utilization rates and significant supply disruptions, but ultimately could boost demand for industrial space, particularly in grocery retail and logistics space. The outbreak could also accelerate the pace of automation and robotization in the industrial sector to reduce the need for labor, JLL analysts added in a report from March 12.
Early data about the total return performance for U.S. real estate investment trusts shows nearly every type of commercial property asset class has been hurt by the coronavirus crisis, with hotels and retail REITS taking the biggest hit. Overall, U.S.-based real estate investment trusts in the hotel sector had total return sink 67.5% this year through March 18 and retail was down 55%, according to Cushman & Wakefield research and REIT industry group National Association of Real Estate Investment Trusts. Office REITs have had total returns performance sink 35% this year through March 18, Thorpe said.
Industrial REITS, which were among the top performers in 2019, had total return performance drop 23% in that same time and storage space REITS had total return performance drop 14.4%. But both properties types are expected to be more resilient through the pandemic, said Cushman & Wakefield in its forecast. As retail stores and malls close nationwide, consumers are shopping for basic necessities online. E-commerce giant Amazon is rapidly expanding its workforce, seeking to add 100,000 new employees as sales surge during the pandemic.
Data center REITS were the only asset class not to have a negative drop in total returns so far this year and posted a 1% gain, according to Cushman & Wakefield. As millions of workers shift to working at home and quarantined consumers turn to Netflix and online socializing, demand for data is expected to soar.
"We expect to see continued growth in this industrial segment, though it’s possible that the trajectory of growth will be offset with business hesitance in making large-scale new investments during this uncertain time," CoStar's Corbett said in an email.
Nearly every industrial space user will likely have to retool their supply chains and make other adjustments, she said.
“These shifts and adaptations are likely to positively drive industrial demand, but they will take longer to unfold," Corbett said.
However, industrial landlords should be prepared if a wave of new speculative industrial space is delayed and construction projects are stalled because of the virus, ultimately those new industrial projects will deliver, shifting power toward tenants, Corbett said.
Doug Harmon, chairman of capital markets for Cushman & Wakefield, said his firm is hearing from clients and investors who are preparing for their next moves after the pandemic, with many investors saying they have ample cash for the right investment opportunities as several occupiers look to monetize assets.
“Business is not frozen. It is active even when the majority of transactional work is on some form of hold. All clients are dissecting, digesting, deliberating, delaying and organizing for this lock down and perhaps this prolonged work-from-home environment,” Harmon said in the webinar.
Recovery Depends on Pandemic
Economic forecasts are bleak for the coming months as jobless claims spike and normal life seems to come to a full stop in many American cities. But many economists seem to be pointing to a sharp recovery in the second half of 2020, as long as the coronavirus' infection rate slows, Thorpe noted.
Oxford Economics is forecasting a brutal 10.8% drop in U.S. gross domestic product in the second quarter of 2020 -- one would have to go back to the Great Depression to see a single-quarter drop in GDP that deep, Thorpe said. But Oxford expects that to be followed by a “v-shaped” recovery, with a dramatic 14.5% jump in gross domestic product in the fourth quarter of this year. Overall for the year, Oxford is predicting real GDP to contract 0.2%.
“In my view, the most important data point to watch is the one that you all are watching: When will the new infection start to slow sharply? “ Thorpe said. Once infection rates drop sharply, then economists can start to model out the timing of the recovery with more accuracy, he said.
It’s not clear when infection rates will slow. A widely circulated report from researchers at Imperial College of London suggests that in order to avoid excessive strain on hospital systems there needs to be social distancing, home isolation and school and university closures until a vaccine is developed, which could take 12 to 18 months.
The “silver lining” in all of this is that in the aggregate, before the crisis, many cities were seeing rent growth, healthy occupancy rates and sustainable increases in property values, according to Cushman & Wakefield.
“Overall, the commercial real estate sector had momentum going into this crisis and so I do think we can take some comfort that we entered with some solid footing, which should make for a quicker return to normalcy,” Thorpe said.
mluck@costar.com
@marissaluck7