Industrial Thriving While Retail Struggles with Challenge from E-Commerce

Industrial – Still Some Room for Growth
The industrial market hit a new height in 2016 with strong performance all around, and the positive trajectory is expected to remain in the near future. More people ordering online might mean fewer people shopping in physical stores, but it also means that more space is needed for storage and distribution centers, and there’s no reason to believe this will change any time soon. With decreasing vacancy and solid rent growth, the industrial market is stronger than ever. Supply lags in most of the regions, particularly in urban infill locations.

Among the regions, the West is expected to see an overall increase in the manufacturing and distribution workers, which will lead to greater demand for space. The trend is declining in the Midwest, increasing in the South, and somewhat mixed in the East.

The main driver behind the strong returns is the healthy mix of appreciation and income return. The West region in particular has seen appreciation return outperforming income return, which is a rare sight given the recent weak appreciation performance in other sectors.

Retail – Beginning to Decline
The continuing rise in e-commerce is placing a great deal of pressure on the retail market. Many major stores are beginning to close across the country and demand for brick-and-mortar space is decreasing. In some sense, this may be both the end of the cycle for retail and the beginning of a new market environment caused by increases in e-commerce.

The two important drivers for the retail industry are personal income and employment, which have been inching up in recent years and making the retail market a bit less prone to a large downward spiral. With strong fundamentals, the income returns are expected to remain solid in the foreseeable future. Given the expected strong rent and employment growth, the appreciation returns will be somewhat steady, albeit downward trending, in the near future and reverting to long-term averages in a few years.

If retailers want to survive in this brutal environment, they have to offer their customers something more than a run-of-the-mill shopping experience. Consumers want to be entertained, because if they’re just looking for a pair of socks they can order them online. But while retailers and brands may come and go, the buildings still remain. If a retail space is located in an easily accessible location, with top-rate amenities, new tenants will move in.

Office – Peak of Cycle
Office sector fundamentals are mixed, particularly by region. Vacancy rates are expected to move higher mainly due to the increase in supply in the South and East regions.

Declines in the office sector may be buoyed by strength in the economy and labor market. Situs RERC predicts that office jobs will continue to grow over the next two years but at a subdued pace as the U.S. nears full employment. It’s too early to tell how automation, AI and the growing trend of people working from remote locations will affect the office sector.

Office sector returns are largely due to the strong performance in the West region, potentially from the employment growth in technology firms in San Francisco, San Jose and Seattle. This trend is likely to continue into 2018. The South and Midwest regions in particular have been showing negative appreciation in the past year, and it is likely to continue to 2017 and part of 2018 because of the oil market performance and oversupply.

As long as the economy and the number of workers keep growing, the office market should do OK. But if we are approaching full employment, that will reduce the need for more office space. In the future, workplace trends such as working from home, automation and AI might pose a threat for the office sector.

Apartments – Entering the Peak of the Market

Years from now, we may look back on the last five or 10 years as a Golden Age for investors in the apartment sector. The economy recovered from the Great Recession and millennials poured into the workforce. As millennials get older and begin to form families, they may decide they want to move out to the suburbs and enjoy some greenery and more space, but until more affordable housing is available, they might have to stay in apartments.

Nonetheless, the strong return performance in the apartment sector is winding down. The sector remains steady, while trending downward and supported by the strong labor market. With resistance in market rent growth, the persistent cyclical nature of the apartment sector sees the demand higher in some regions and lower in others.

High rents and increasing pricing, accompanied by improving economic conditions, place the apartment market close to the peak of its cycle. The pace of construction activity may cause issues and some indications are that the market is getting ahead of itself.

Many Situs RERC survey respondents have indicated that overbuilding/construction is the primary concern for the sector. Although the primary markets may have reached their peaks, there is still room for an expansion in secondary markets such as Austin and Nashville.

The West and the East regions are expected to experience high employment growth in financial, business and technology sectors, which will drive the apartment market. The apartment sector is being buoyed by millennials’ unwillingness or inability to buy homes.

Although the overall apartment sector appreciation cycle has come to an end, appreciation returns in the West region remain healthy, and the trend is likely to continue in the short term. For the rest of the regions, the apartment returns are expected to revert to their long-term average in the next few years.