Prologis research highlights sustainable growth pattern for logistics real estate

Research recently issued in a report by San Francisco-based real estate investment trust company Prologis pointed to stable market conditions for the industrial real estate market, in the third quarter.

The report, entitled, “Logistics Activity Trending Toward Sustainable Growth”, highlighted key findings from the Prologis IBI, which is a quarterly survey of customer sentiment. The IBI pointed to what Prologis called an environment of normalization away from the unsustainably high levels of activity recorded in 2018” (and came in at 60 for the third quarter; a reading of 50 or higher indicates growth is occurring) with:

• operating conditions remaining healthy, with market vacancy near 4.5%;
• net absorption of 225 million square feet (MSF) and 240 MSF of completions in 2019, with market vacancy near the current historic low of 4.5%;
• around half for U.S. development activity begun over the last four quarters was concentrated in six low-barrier markets, which further reduces supply risk, coupled with supply rising in smaller multi-market distribution hubs

At a time when logistics activity is normalizing, Prologis pointed to underlying demand drivers, with macroeconomic conditions are generally downshifting, as leading economic conditions show a continuation of steady growth, in the form of a 50-year low for unemployment and still-high consumer confidence, which has gone through a “controlled descent” in recent months, while consumption still is in a position of strength as an economic growth driver and a structural driver of logistics demand.   

In an interview, Melinda McLaughlin, Prologis vice president of research, said that the IBI’s results represent a continuation of the 2019 theme of things continuing to return to normal and sustainable healthy growth levels.

“The IBI reading of 60 represents healthy and sustainable growth, and we contrast that with 2018, as it was kind of an outlier year for logistics real estate,” she said. “This is because of things like the tariff impact, which led to a frenzied amount of activity in logistics warehouses that just wouldn’t be sustainable for the long term. We saw the IBI peak at 70 in late 2018 and then come back down to the more sustainable level of 60 throughout this year. It has really hovered around that level, suggesting continued growth but more in line with the planned progression of the businesses expanding, rather than somebody trying to respond to a kind of new and unplanned situation.”

While the IBI is slightly down, McLaughlin reiterated that the current level reflects strong and healthy growth, in terms of the flow of goods through logistics facilities, which Prologis pairs up with the utilization rate.

This pairing, she explained, shows a very similar pattern, which ties back to the qualitative feedback Prologis has received from its customers.    

“Utlilization likewise peaked in late 2018,” she said. “If you are rushing to try to take in imports ahead of any kind of tariff imposition, you are going to stuff your warehouses as full as they can go. We saw utilization rise to about 87%, which, again, is unsustainably high. But, if you think about the flow of goods into your facility, you need space for people, forklifts, and other machinery and need space to flow. In 2019, it has come back down, and we have seen that rate hover between 85% and 86%, which is a very healthy level. If we start to see it descend, that would suggest that there is some shadow space out there, so customers may have more space than they need, but it is not what we have seen at all this year. It seems like things are on very healthy growth patterns and very sustainable and in line with the 2%-to-3% GDP growth economists forecast for this year.”

When asked why about half of U.S. development activity begun over the last four quarters was concentrated in six lower-barrier markets-Dallas, Houston, Chicago, Atlanta, Pennsylvania, and the Inland Empire (East), she attributed it to two factors.

One is that vacancy rates in most markets have fallen to all-time lows, even in some smaller markets that might have had a historically relatively-high vacancy rate.

“[In] Los Angeles, where it is very difficult to build and there is a lot of demand, vacancies there have stabilized around 1%,” said McLaughlin. “And then there is a market like Columbus, with a little more land and easier to build, may have historically been in the upper single digits. We see vacancy rates today, for a number of metro areas that are sub 5%. When you have healthy market conditions, it obviously spurs rental growth and that is attractive to development. There is pure development economics happening in these smaller markets, and there is demand there. In order to have a vacancy rate that falls to that level, you have to have some demand growth.”

What’s more, McLaughlin added Prologis sees a lot of capital flow into the logistics real estate sector hoping to be put to work, leading to an aspect of with the search for yield and opportunity, not everybody can only play in top markets, and are looking for opportunities among a broader group of markets, which disperses a little bit of the supply risk.