By Peter Grant
Investors in recent years have been ho-hum about online
shopping's potential as a growth engine for companies that own
warehouses and distribution centers.
Now Wall Street is giving that a rethink.
Shares of real-estate investment trusts that own industrial
space have soared 17.3% this year, compared with 6% for all equity
REITs and 1.7% for the S&P 500, according to Green Street
Advisors.
In 2015 and 2014, by comparison, industrial REITs underperformed
the real-estate market by 0.6% and 9.1%, respectively, Green Street
Advisors says.
Analysts believe that internet retail accounts for much of the
increase in demand for industrial space. At the end of 2015,
tenants in the top 47 markets occupied 101.7 million more square
feet than they did at the beginning of the year, according to data
firm Reis Inc. That is up from 93 million in 2014.
This year's exuberance partly reflects the strong first-quarter
earnings posted by industrial REITs such as Prologis Inc. and Duke
Realty Corp. But the rally also is a sign that investors are
recognizing that online retail is going to have a deeper and longer
lasting impact on demand for industrial space than previously
expected.
One big reason: Processing goods for online distribution is
proving to be more complicated and requires more space than
processing goods for bricks-and-mortar stores. Prologis, the
country's largest industrial REIT, estimates that every dollar of
online sales needs three times more distribution-and-warehouse
space than one dollar of bricks-and-mortar sales.
"Even if retail sales in the economy stay constant, just a shift
from stores to e-commerce is going to grow industrial demand," said
Hamid Moghadam, chief executive of Prologis, which controls 667
million square feet of industrial space world-wide.
The growing appeal of industrial REITs contrasts sharply with
the pain that online shopping is inflicting on other parts of the
retail world. Major retail companies such as Macy's Inc. and Sears
Holding Corp. are getting hammered as consumers increasingly shop
online.
Last year, 7% of U.S. retail sales were online, compared with
3.9% in 2009, according to a Green Street Advisors analysis of U.S.
Census Bureau data.
Meanwhile, an April report on the industrial sector by Green
Street Advisors pointed out that U.S. inventory levels have been
rising faster than sales since 2011.
Analyst Eric Frankel said that is partly because e-retailers
have needed to keep more inventory on hand as they promised
customers shorter delivery times.
"People are saying 'I want my shipment in one or two days,'" Mr.
Frankel said. "That has an impact on inventory."
E-retailers also require more inventory space because moving
their goods tends to be less efficient than moving inventory for
stores. "If you look at major retailers like Wal-Mart, warehouses
are set up to send truckloads of goods to individual stores," said
James Connor, chief executive of Duke Realty. On the other hand,
online distribution centers "are set up exactly the opposite," he
said. "Everything goes out in onesies and twosies."
As online retail has grown, few expected industrial REITs to be
hurt. But it hasn't been clear how much they would benefit.
Many believed retailers would be able to store both online and
bricks-and-mortar inventory in existing distribution
facilities.
Also, the industrial sector suffered a severe space glut in the
aftermath of the 2008 crash. Investors became painfully aware of
how easy it was for new space to be built, and many remained wary
of industrial REITs during the current recovery.
But so far in this cycle, many industrial REITs have restrained
their urge to develop a lot more new space. For example, Duke has
preleased 79% of the $650 million worth of new space it is
developing.
In 2008, only 15% of Duke's space under development was
preleased, Mr. Connor said.
"We haven't all gotten together and shot ourselves in the foot
by overbuilding the market," he said.
Mr. Hamid believes that as online shopping grows, retailers will
have to shift from traditional distribution facilities to those
structured around "parcels instead of pallets." The change would
take place more quickly if retailers weren't already committed to
current leases, he said.
Analysts and executives at industrial REITs caution that all is
not smooth sailing ahead for the sector. A slowdown in the economy
and consumer spending would push vacancy higher and rents down.
What's more, e-retailers are still in the early stages of
figuring out new methods for delivering goods from distribution
facilities to households. It isn't clear how demand would be
affected throughout the supply chain if there is a big push to
convert relatively small downtown buildings into distribution
facilities.
Mr. Frankel points out that demand for industrial space also may
decelerate as internet distribution becomes more efficient. He
notes that a huge online retailer like Amazon.com could "curb
overall demand" by greatly increasing its offering of its logistics
services to smaller retailers.
Mr. Hamid said he isn't concerned about a threat from Amazon,
partly because companies like Prologis are going to benefit as long
as shopping shifts from bricks-and-mortar retailers to
e-commerce.
"If you take the same number of goods and stack them in pallets,
and take the same number of goods and put them in boxes ready for
[online] shipping, it's going to take more space," he said.
(END) Dow Jones Newswires
June 14, 2016 16:55 ET (20:55 GMT)
Copyright (c) 2016 Dow Jones & Company, Inc.
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