09/22/2014 | by
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As the global economy continues to regain its footing, the industrial REITs that are so vital to the flow of commerce are seeing some positive tailwinds in their favor. In particular, the emergence of a middle class in China and Brazil and the rise of e-commerce in Europe and Japan are creating an environment for success for industrial REITs with a global presence. Industrial REITs are also benefitting from the demand for facilities that can meet growing demand for quick—even same-day—retail deliveries to consumers.

“There are advantages to being a global player,” says Chris Caton, vice president and head of research at U.S.-based industrial REIT Prologis (NYSE: PLD). “First, our customers are global, so we need to provide them with services everywhere they are. We can help them grow their business, too, because we can do things like work with a Japanese retailer in France or vice-versa.”

Global companies also can ratchet up or down development, acquisition, disposition and operational strategies by market, instead of being tied to one locale, Caton says.

As an asset class, the industrial sector is focused around distribution centers whose tenants are global, such as Amazon, says Scott Crowe, managing director and global portfolio manager for Resource Real Estate.

“Right now, these industrial REITs are responding to the redesigned supply chain and the need for more efficient assets and automation,” he says. “We came out of this recession with a different economy, with technologies emerging that change where people work and how they live. We haven’t had a change on the supply side for 20 years, so the industrial sector is in the midst of addressing that.”

Demand Drivers in the Industrial Sector

Given the lack of modern facilities, there is huge potential to improve the efficiency of logistics in China, Japan and Brazil, says Jeffrey Schwartz, co-founder and chairman of the executive committee of Singapore-based industrial REIT Global Logistic Properties (SGX: GLP).

“The demands of domestic consumption are not being adequately met by the logistics infrastructure in China and Brazil, resulting in logistics costs as a percentage of GDP twice as high as developed countries,” he says.

Caton says the industrial sector is impacted most by consumers and retail performance. Globally there are opportunities in countries with an emerging consumer class. In Japan, where the economy doesn’t grow as rapidly, there are opportunities because of the reconfiguration of the supply chain, he says.

“The primary demand driver in the U.S. and on a global basis in this sector is the need for state-of-the-art space for tenants,” says John W. Guinee, III, managing director with Stifel Nicolaus. “Just a decade ago everyone wanted a bigger centralized distribution center, but now people want e-commerce facilities to be more automated than a typical distribution center, taller and to have parking for trailers and for the people who work there. They’re still centralized, but now they’re centralized in areas with tight demographics so they can reach more people faster.”

Schwartz says that domestic consumption is a key driver of demand for his company. More than 80 percent of its portfolio caters to that segment of the market.

“In China, continuing urbanization and rising household incomes continue to drive domestic consumption,” Schwartz says. “In Japan and Brazil, demand for our facilities is driven by systematic supply chain modernization as companies move towards outsourcing logistics and shift from a strategy of owning warehouses to leasing them.”

Schwartz says space leased by e-commerce customers in China has increased at a compound annual growth rate of 105 percent, while its share of total logistics-leased area has increased from 4 percent in 2010 to 25 percent today. Transportation/express delivery clients driven by e-commerce have also expanded rapidly within the firm’s platform, up from nearly zero in 2010 to 8 percent today. In Japan and Brazil, e-commerce-related customers make up 11 percent and 21 percent of Global Logistics’ leased area, respectively, he says.

Supply Constraints in the Industrial Sector

Caton says the transition to a more global economy over the past 30 years has changed the industrial property sector.

“The location of warehouses used to be driven by taxes, but now there’s a demographic shift to be closer to larger numbers of consumers because of the emphasis among retailers of next-day delivery,” says Jon Petersen, vice president of equity research at MLV & Co. “This is not only in the U.S., but also in Europe, Singapore, Hong Kong and Tokyo.”

Right now, industrial REITs are benefitting from a lack of supply, so they’re enjoying above-average rent growth and above-average occupancy rates, according to Petersen.

“In Asia, lack of supply means there’s not much opportunity for acquisitions, so everything is ground-up development,” Petersen says. “In Europe, there’s mostly older product with a high rate of obsolescence, which gives companies an opportunity to buy up existing warehouses and redevelop them.”

In Europe, just like in the U.S., Caton says everything’s on the table in the industrial sector: acquisitions, redevelopment and development.

“Europe is a different case than Asia and Latin America, although it’s a growth market for logistics, too,” Caton says. “The European market is only about 15 years old, in part because it wasn’t a unified market until the rise of the euro and the decline of trade barriers. Now that it’s emerging as one market, there’s a role for us in solving supply-chain issues.”

Challenges for Global Industrial REITs

The basic challenges of working with customers who are located in different time zones and speak a variety of languages are relatively easy to overcome, according to Guinee. Yet, he says industrial REITs that invest overseas face other challenges, too, such as access to land in convenient locations near highways and ports. In his experience, favorable infrastructure features are the exception rather than the rule in less-developed countries.

Caton points to a handful of other potential roadblocks in international markets.

“There are some local challenges, such as in Brazil, where the hilly topography means we have to level mountains to build,” he says. “In Japan, we have to build seismic-resistant buildings due to the threat of natural disasters and multi-story buildings because of the expensive land there.”

Guinee also notes that industrial real estate companies face two other significant challenges: legal issues and taxes.

“In the U.S., we work under the rule of law for things like zoning, permits and approvals,” Guinee says. “Overseas, most REITs need a joint-venture partner or to hire exceptionally knowledgeable and senior local people. Also, when U.S. REITs go overseas they’re subject to the tax laws of that particular country, so those developments are far less attractive from a tax perspective.”

Expectations Remain High for the Near Term

The industrial sector needs a recovering economy to thrive, and that has only recently started to take hold, according to Caton.

“People are underestimating the strength of this real estate market,” Caton says. “I think a constrained recovery is a good thing for the industrial sector. Rental growth should be good for the next 12 to 24 months.”

Petersen also says he expects the industrial sector to outperform for another year or longer. He says Asia’s relative strength during the recession suggests that while there will still be growth there, it’s likely to be at a more moderate rate. In Europe, he anticipates a longer period of rent growth because the region is still near the beginning of the recovery.

For many companies in the space, like Global Logistics, growth is likely to be accompanied by more building.

“Given the compelling opportunities we see across all of our markets, we remain confident in our ability to accelerate growth and target to initiate $2.7 billion of development starts in China, Japan and Brazil in [2015], up 38 percent year-on-year,” Schwartz says. Those projects include annual increases in development expenditures in China on the order of 30 percent to 40 percent for the next three to five years.