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Landmark Links May 29th – Tailwind

One Big Thing

While still early on in this recession, I think its already fair to say that ecommerce is a big winner coming mostly at the expense of brick and mortar retail – especially of the mom and pop variety.  As warehouse is largely a proxy for ecommerce, it stands to reason that it will also be a relative winner. This will likely accelerate an long-term trend of demand outpacing supply, leading to paltry vacancy and low cap rates.  The increase in demand in this space has been due to a secular change in the supply chain and consumer behavior, not cyclical forces.  A recent report from ProLogis illustrates just how much net demand is being created (emphasis mine):

Each 100 bps of share shift from bricks and mortar to online translates to 46 MSF of net demand in the U.S. With the penetration rate already rising by 100-150 bps annually, March through mid-April’s e-commerce growth of 30%+ suggests that the rate could rise by 300-400 bps in 2020, generating an incremental 140-185 MSF of net demand (accounting for cannibalization of bricks and mortar). Some of this demand has already surfaced in the race to respond to the coronavirus pandemic, but the reality of implementing this expansion in distribution capabilities may take more than a year to complete. In addition to growing retailer demand, parcel delivery and paper/packaging businesses should benefit from increased direct-to-consumer shipments.

That’s a huge increase in net demand.  When you consider that the total warehouse inventory in the US is around 10 billion square feet, the high end of the demand range would account for 1.85% of the existing stock in 2020 alone.  This becomes even more insurmountable when you consider that:

  1. Vacancy is already below 6% nationwide – and MUCH lower than that in prime markets, and
  2. A very large percentage of the existing warehouse stock is outdated and not equipped for ecommerce activity.

What’s outlined above is more than enough to justify a bullish thesis for the warehouse space but there’s another part of the story putting even more downward pressure on vacancy and upward pressure on rents: inventory. Again,from ProLogis (emphasis mine):

Each 100 bps of growth in inventories is estimated to require an additional 57 MSF of U.S. logistics demand. Returning the retailer inventories-to-sales ratio from 1.45 to the 1990’s average of 1.65 would require inventory growth of 15%, holding sales constant. While this likely represents the high-end of the potential response, the pandemic has laid bare the trade-offs supply chains have made in tuning for efficiency. They were unable to serve customers and as a result lost revenue. Holding additional inventory is manageable for all customers and relatively easy to implement. In addition, carrying costs will remain low given record-low interest rates. We modeled 5-10% inventory growth, which would produce additional space needs of 285-570 MSF in the U.S. We expect this shift to lead to broad-based logistics real estate demand growth, with an emphasis on large consumer populations, access to transportation and modern facilities.

If taken in conjunction with the ecommerce net demand above, this results in an increase of net warehouse demand of somewhere between 4.7% and 7.6% of existing stock.  Even at the low end, that is simply a massive shift.  It is at this point that I’ll acknowledge that ProLogis is talking their own book since they are the largest industrial real estate owner, operator and developer in the US.  However, nothing in the report appears to be inaccurate or really all that speculative.  Malls were dying before COVID but the pandemic accelerated things.  Ecommerce and warehouse demand was booming before COVID and the pandemic will likely accelerate that trend as well.  In short, if you are looking for distress in the coming months, it most likely won’t be found in the warehouse sector.

What I’m Reading

Chopping Block: Many employees fortunate enough not to get laid off are seeing their salaries reduced instead.

Floor: Despite a wider-than-normal spread, it may be difficult for mortgage rates to fall too much lower from here thanks to fixed transaction costs.

Overhang: As we approach the end of most lenders’ forbearance periods, a question looms  – what will happen next with the $150 billion of frozen loans that are currently in limbo.

Step in the Wrong Direction: SB 939 would enact a moratorium on commercial eviction for small businesses and nonprofits during the COVID state of emergency as well as allow allow hospitality tenants who have lost over 40% of their revenue or operating at 25% capacity to renegotiate and modify their leases.  Under this bill, if an agreement can’t be reached after 30 days of negotiations with their landlords, the tenant would be allowed to break the lease with no penalty.  The bill advanced through the Senate Judiciary Committee on Wednesday and is now headed to the Senate Appropriations Committee. It goes without saying that this would be a catastrophe for landlords.

Chart of the Day

Buyers pulled back much quicker in the COVID recession than they did in the GFC.  That doesn’t mean that prices will fall further but does perhaps indicate that price discovery will happen somewhat sooner.

Source: Real Capital Analytics

WTF

Thoughts and Prayers: An 84 year old alligator named Saturn who was rumored to be Hitler’s “pet” has died at the Moscow Zoo.  No word as to whether the death was COVID related.

Always the Ones You Least Suspect: Two men were arrested after stabbing another person and barricading themselves in a North Carolina apartment but that’s not why I’m posting this story in WTF.  You have to check out this mug shot.

Flattening Curves: A couple put flyers for an Avengers themed orgy to “celebrate” the end of quarantine around their Philadelphia neighborhood.  While the event started as a joke, the pair have received so many inquiries that they now intend to actually host it.

Landmark Links – A candid look at the economy, real estate, and other things sometimes related.

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