It is hard to turn on the news these days without hearing about the trade war and its potential impact on consumers, business owners and real estate investors. Some days there is positive news, and others seem more dire. Given all the wavering predictions, Xebec wanted to take a step back and share how we are thinking about the trade war and its potential impact on commercial real estate (“CRE”) and more specifically our focus area of industrial real estate.
There may be uncertainty out there, but what we do know is that eCommerce is a strong force to help keep industrial real estate insulated from the potential impacts of the trade war. Many factors seem to indicate that industrial real estate space will continue to be in demand as eCommerce sales grow. Here is how we are looking at the potential trade ware impacts on the CRE industry.
TARIFFS AND POTENTIAL IMPACT ON CRE COSTS
Without a doubt, the marginal increase in the cost of steel as a result of the tariffs can increase the price of new construction. This increase though is largely dependent upon the CRE asset class involved. Each of the five CRE asset classes (industrial, retail, hospitality, multifamily and office) require different amounts of steel as part of the overall construction – and industrial real estate generally uses less steel than the other CRE asset classes. Xebec’s focus is on concrete tilt-up facilities which require significantly less steel than office or high-rise multifamily structures.
In addition, while Trump’s tariffs have focused on China, it’s important to note that less than 3 percent U.S. imported steel comes from China. In fact, the U.S. imports most of its steel from Canada, Mexico and European Union. After the signing of the United States-Mexico-Canada Agreement (USMCA) in November 2018, officials are still working to lessen or eliminate tariffs on goods from Canada and Mexico, leaving a revved-up domestic steel production pipeline with the opportunity to offset the cost of imported steel and meet the construction demand.
CRE’S SUPPLY CHAIN POSITIONING & WHY IT HELPS INSULATE IT FROM POTENTIAL TARIFF IMPACTS
Another key to understanding the trade war’s impact on industrial real estate lies directly within an understanding that the consumption end of supply chain is helping drive the continued demand for industrial logistical real estate facilities. The tariffs announced thus far pose a concentrated risk at the production end of supply chains (e.g., raw materials), potentially decreasing production and/or demand for goods.
In contrast, industrial real estate is positioned at the consumption end of the supply chain (which includes regional warehouses and infill / last mile fulfillment centers), and even if there is a slow down on the production side of the supply chain we still anticipate the continued strong demand for modern industrial buildings. eCommerce, supply chain modernization, and economic expansion have created unprecedented demand for new industrial facilities. Every $1 billion of goods sold through eCommerce channels requires 1.25 million square feet of industrial real estate. Black Friday 2018 hit a new on-line sales record, with a 23 percent increase in online sales from the prior year. Over the next several years, total eCommerce sales are expected to grow 7.5 percent year-over-year through 2022. The trade war may adversely affect the overall growth of eCommerce, but we believe users nonetheless will create a significant demand for industrial real estate in the next several years.
LIMITED INVENTORY & RENT PRESSURE
The significant demand for industrial real estate logistics facilities is projected to outpace supply in major markets nationwide and should continue to buoy rental rates for the foreseeable future.
Los Angeles County, for example, has an average 1.4 percent vacancy rate for both industrial warehousing and manufacturing space, and has experienced nearly a 10 percent increase in rental rates over the last 18 months, according to JLL’s market research. The current pace of both demand and construction provides confidence that rents will continue to rise throughout the next 18 months. Furthermore, according to many brokers across Southern California, there hasn’t been any pullback in the number of property tours or interested parties in industrial space.
This market profile is similar across all of our target investment regions. According to JLL, the scarcity of available industrial space nationwide is persistently providing upward pressure on rents. The increase in rents favorably impacts investment returns for opportunistic and value-added investment opportunities, offsetting the possible higher costs that could result from tariffs should balance out to produce favorable returns.
OUR CONFIDENCE IN INDUSTRIAL REAL ESTATE
Industrial real estate has been the highest performer of all of the CRE asset classes for the past 20 years. With the confidence to purchase consumer goods, the imbalance of supply and demand for space from eCommerce companies, and the minimal impact from the imposed tariffs, we believe industrial real estate investments will remain a solid choice for the foreseeable future.