Why Core Real Estate? | Investment Perspectives

The Case for Modern Logistics Facilities

October 18, 2023 30 Minute Read Time

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A case of as you were?

In this Case for Logistics series, Paper 1 looked at how long-term structural drivers, including e-commerce, reverse logistics, supply chain reconfiguration and re-shoring/near-shoring, have propelled industrial asset performance to record levels Given the structural shifts the industry is experiencing as a result of global retailers attempting to create long-term efficiencies, the Case for Logistics appears to be intact. A case of as you were then? Investors need only gain exposure to the sector, sit back and reap the rewards? Not quite.

Over the past year, occupiers have been confronted with a combination of pressures not faced previously with some continuing to persist: decades-high inflation, sharply higher borrowing costs and rising sustainability standards. As they tackle a range of issues from slow supply chains to higher labor costs and more demanding consumers, occupiers are increasingly taking a more considered approach when it comes to their logistics footprints.

Similar to the current state of the office market where assets with modern amenities and smart design features are materially outperforming legacy office buildings which lack functionality and do little to attract talent back to the office, modern logistics facilities are poised to separate themselves from older obsolete product. Modern, innovative properties that support productivity and sustainability goals are being favored. Location and proximity to large consumer bases in primary markets are also becoming more important. Modern assets in prime locations that can meet occupiers’ needs today and accommodate those of tomorrow stand to benefit most. The divergence in performance between modern and legacy assets is, therefore, expected to widen further. If occupier needs are changing, it follows that investors need to adjust their portfolios accordingly.

Putting the ‘modern’ into modern logistics facilities

CBRE Investment Management categorizes logistics facilities broadly based on their proximity to the end consumer—intermodal, distribution, and fulfillment—as depicted by the graphic below and defined by the following attributes.
Figure 1

INTERMODAL: >350K SF

The consumer product reaches its first destination in the supply chain with at least three more points of delivery: distribution, fulfillment, doorstep.

  • Market Type: Logistics hubs, ports, airports, rail
  • Locations: Strategic, transport-driven hubs for national distribution

DISTRIBUTION: 350K TO 1M SF

Consumer product is received from its point of origin in the supply chain and is resorted/repackaged. Product has at least two more points of delivery: USPS/FedEx/UPS and doorstep for E-commerce, delivery to brick & mortar storefront with the consumer completing the last mile or fulfillment followed by doorstep delivery.

  • Market Type: Large population centers, regional distribution
  • Locations: Interstate corridors/thoroughfares accessing major metropolitan areas

FULFILLMENT: <350K SF

Consumer product reaches the last stage of the supply chain and is delivered from the fulfillment center direct to consumer (B2B or B2C model).

  • Market Type: Large population centers, urban
  • Locations: Urban fringe/commercial areas, urban districts

A growing checklist

While the above broad categories may not have changed much in recent years, the checklist of occupier requirements for logistics assets has. Today, tenants want their logistics facilities to be highly customized and sophisticated operations with significant automation capabilities. Occupiers are also looking for features that meet their own corporate sustainability goals, such as LEED certification and renewable power. Amenities that help them recruit and retain labor have also become increasingly important in what is an extremely competitive job market.

Examples of modern features include:

  • Enhanced Power: Occupiers seek facilities which can accommodate conveyor belts, truck carousels, electric vehicles (EV) charging, battery storage capacity, automation and internet connectivity. Increasing use of technology requires reliable, secure and cost-effective power supplies such as rooftop solar panels, enhanced electrical conduit throughout the truck court, closed-loop battery storage onsite and EV charging stations. Buildings with renewable energy sources onsite, such as rooftop solar panels, provide a more sustainable solution—a rooftop installation can power up to 80% of a facility’s energy use. In addition to the increasing use of technology within the warehouse, occupiers have already begun to purchase EV truck fleets which will further necessitate the need for onsite power and a closed-looped battery storage facility on site. Utility providers are already stretched given the lack of proper infrastructure in some regions of the United States. Adding in the increased power needs globally given the proliferation of artificial intelligence (AI) and the data centers needed to power AI, it’s easy to conclude that existing power grids across the country will be further stressed. Access to reliable, sustainable power will be one of, if not, the most important amenity to future-proof logistics assets.
  • Roof load: Additional RTUs (roof-top-units) with appropriate tonnage are required more frequently to create enhanced comfort for human capital and cooling for heavy mechanical systems for conveyance of product throughout the warehouse. Roof loads above 15 lbs. per square foot vs. the prior roof load standard of 9-10 lbs. per square foot are becoming the norm. Existing roofs of older industrial assets without appropriate tonnage to support HVAC and solar panels will likely have to be replaced resulting in material capital expenditures.
  • Clear Height: The clear height of a structure determines the quantity of goods that can be stored on a cubic basis, which is quickly becoming the utilization rate most focused on by users. Occupiers are now looking for clear heights of 36-40 feet compared to older buildings’ 18-32 feet. Since occupiers pay rent on a linear square footage basis, the cost per SKU associated with storing more product on a cubic basis creates enhanced efficiencies and amplified operating margins. 
  • Column Spacing: The distance between columns or vertical support beams determines how space can be utilized, which types of goods can be stored, how easily, efficiently, and quickly they can be accessed and moved, the size and positioning of racks and the design of conveyors, walkways, picking lanes, receiving and staging areas. Column spacing must match an individual occupier’s racking plans and, therefore, needs to offer increased flexibility both on the warehouse floor and speed bays. For example, warehouse operations require the integration of multiple types of proprietary racking systems for "big and bulk" product (deeper racks) and smaller/intricate items (shallow shelves). This creates flexibility to introduce "Very Narrow Aisles" (VNAs) and automated racking such as Kardex Systems.
  • Enhanced utilities: Occupiers seek enhanced utilities within logistics buildings such as increased water supply and overall energy efficiency. Larger and taller buildings require adequate water pressure to support fire suppression systems. Where there is insufficient pressure, water pumps are needed, but it can be expensive to retrofit ESFR sprinkler systems. Additionally, energy efficient buildings not only generate cost savings for businesses they also help meet sustainability requirements. 
  • Floors: Slab conditions or slab specifications with a heavy focus on seamless and 7”+ reinforced slabs are needed to support enhanced structural roof upgrades and the load carry capacity required for conveyance/material handling systems. Additionally, super flat floors that are durable and seamless are required for robotic automation such as the Kiva robot systems synonymous with Amazon fulfilment centers. 
  • Truck court depth: No longer just an outside space, yards can include truck courts with maneuvering areas, trailer parking for onsite storage and ample car parking. A high number of dock doors increases the flow of goods. A truck court depth of 130 feet or more also makes it easier to move truck fleets around ensuring quicker loading and unloading.
  • Embodied carbon: A building’s energy efficiency as well as its construction is an important sustainability consideration. Buildings constructed with more sustainable materials can reduce occupiers’ carbon emissions.
  • Amenities: Amenity-rich buildings with gyms, showers and outdoor space can help reduce staff absences and attract and retain employees. Talent procurement and retention for warehouse occupiers has been critically important over the last few years as U.S. warehouse employment grew by over 58% from January 2018 to January 2022.1 Facilities that offer amenities and increased quality of life can reasonably be predicted to experience increased talent procurement and retention.

Figure 2

The top five 

According to the Fall 2022 CBRE Occupier Survey, the top five features occupiers sought for new warehouses were:

  • Clear height
  • Number of dock doors
  • Power supply (all types of power, not just for EVs)
  • Column spacing
  • Capacity for expansion

The same survey indicated that occupiers are looking to use technology and automation to increase efficiencies in the warehouse to both combat wage and labor issues but also to increase utilization and enhance fulfilment times. Walmart recently made news headlines by suggesting that by 2026, roughly 55% of all SKUs would be processed through fully automated logistics facilities. We have recently experienced this occupier preference in real time. The largest and most creditworthy tenants recently modified their standard Request for Proposal template used across the globe to narrow options early in the search process to identify assets with higher specification standards in a way that hasn’t been seen in the previous 15 years in the industry. Today’s users are actively seeking modern specifications such as reinforced slabs, roofs that can support 10+ pounds of dead load, areas for trailer stalls, etc.

Location, location, location

Proximity to the consumer is another key requirement. As volumes of goods grow, ranges increase and delivery timing gets tighter, logistics assets are not only required to be fit-for-purpose in terms of providing the cutting-edge facilities occupiers are looking for, but also be close to large concentrations of consumers. Not only does being closer to the consumer enhance delivery times, it reduces costs for occupiers. CBRE Supply Chain Advisory estimates that rent and other fixed facility costs only makes up approximately 3%-6% of a company’s total logistics spend while transportation costs account for approximately 45%-70% of a company’s logistics spend; thus, more infill locations closer to consumers allows for occupiers to reduce their largest logistics costs. CBRE research suggests certain major e-commerce logistics occupiers are re-evaluating occupied space with the intention of finding more suitable locations and sizing for their footprints as part of ongoing broader efforts to build capabilities. Bottom line, occupiers are being more selective.

Although broad cap rate compression occurred through 2022 in all markets, including primary, secondary and tertiary markets, CBRE Investment Management expects primary markets to outperform over the short and long term. Historically assets in primary markets experienced a 100 basis point cap rate differential versus assets in secondary or tertiary markets. Through the end of 2022, we saw the cap rate differential compress to roughly 30-40 bps. However, given recent valuation declines as interest rates and valuation metrics increase, we are starting to see a reversion to the historic norm, insinuating that primary markets are expected to outperform once again. Furthermore, logistics assets in U.S. coastal markets and the south, known as the ‘smile’ markets, will likely outperform due to strong demographic trends. At the asset level, rents in the intermodal and fulfillment categories should continue to see strong growth—intermodal assets due to demand at ports being driven by an influx of incoming inventory, fulfillment assets due to the rapid delivery timing expectations of consumers. One major global e-commerce occupier recently signaled plans to double their fulfillment center footprint over the next few years as same-day delivery expectations have become the norm.
Demand drivers, consumers, barriers to entry, historical operating fundamentals, peak/trough vacancy rates and cap rates are key determinants of whether a market is primary, secondary or tertiary.

In short supply

Demand for modern logistics is high, but what about supply? Analysis of the vintage of the U.S. inventory of logistics assets reveals that the average age of a warehouse building is over 43 years old, more than 82% of assets were built before 2000 and over 30% are more than 50 years old. While nationally there is still a sub 4% vacancy rate for logistics assets as of Q2 2023 inclusive of secondary and tertiary markets, only 25% of vacant assets are less than 20 years old and only 5% are between 10 and 20 years old.2 A large proportion of vacant space wouldn’t even be considered by today’s occupiers given these assets may be functionally obsolete, making vacancy rates considerably tighter than headline rates suggest. Modern logistics facilities are in short supply and where there’s scarcity there’s value. Occupiers are willing to pay more rent for new or recently built assets featuring best-in-class design standards. Modern logistics facilities in select markets are projected to see outsized rent growth over the next five years.

5-year average logistics market rent growth forecast (Q3 2023-Q2 2028)

Figure 3

Source: CBRE Investment Management, forecasts as of Q3 2023. For illustrative purposes only. Based on CBRE Investment Management's subjective views and subject to change. There can be no assurance any targets or business initiatives will occur as expected. Forecasts are inherently uncertain and subject to change.

CBRE Investment Management projects that modern logistics assets are poised for outperformance based on year-over-year average total return for the next five years compared to legacy logistics. We also project that modern logistics assets will see heightened cap rate compression over the next 10 years compared to legacy logistics.

5-year outlook, %Y-o-Y average

Figure 4

Source: CBRE Investment Management, forecasts as of Q3 2023. For illustrative purposes only. Based on CBRE Investment Management's subjective views and subject to change. There can be no assurance any targets or business initiatives will occur as expected. Forecasts are inherently uncertain and subject to change.

U.S. logistics cap rates, modern vs. legacy

Figure 5

Source: CBRE Investment Management, forecasts as of Q3 2023. For illustrative purposes only.

Not an option

An obvious solution to the lack of modern supply would be to retrofit/redevelop legacy space, but this is often not practical or cost effective. For example, if an occupier was leasing an older industrial asset and wanted to install robotic automation technology, upgrading the warehouse floor to create a seamless slab would be necessary. However, it would likely be impossible to pour over the existing concrete flooring given concrete doesn’t adhere to concrete.  Even if you could add additional concrete to create a seamless slab, you’ve now lowered the building’s clear heights potentially impacting the occupier’s racking abilities and you’ve required the tenant to vacate the premises (and therefore not pay rent) during the time required to create the seamless slab. Similarly, increasing live roof load isn’t an option without tearing off the entire existing roof, requiring the tenant to vacate the premises and incurring capital expenditures of approximately $30 per sq. ft. in select markets.

Because of challenges such as the above, CBRE anticipates that the divergence being seen between demand for modern and legacy assets will widen as more leases roll over and occupiers look to upgrade their supply chain footprint and delivery speed.

Today’s tight capital markets also need to be considered. Per CBRE Research, “Difficulties in construction financing have led to continued declines in U.S. industrial construction starts. At mid-year only 59.6 million sq. ft. of industrial product broke ground, the lowest total since the onset of the pandemic. The decline in starts dropped under construction product in 67% of the markets tracked by CBRE Research leading to 577.8 million sq. ft. under construction, the first time the total under construction was below 600 million sq. ft. since Q1 2022.” With new development plummeting, a material undersupply of first generation modern assets in the back half of 2024 and 2025 should be expected. Availability is, therefore, expected to remain below the long-term average, leading to double-digit rent growth, particularly in primary markets and emerging markets with strong population growth.

Change is in the air

Gone are the days when logistics investors could hitch a ride on a rising tide that promised to float all boats (assets). Today, occupiers are facing multiple pressures such as high inflation and interest rates, along with rising sustainability and employee-wellbeing standards. Occupiers have a growing checklist of requirements that logistics assets must meet. Logistics footprints are, therefore, being re-examined in favor of those assets that more closely match occupiers’ needs.

Although logistics real estate at the subsector level remains poised for growth, at the asset level, returns are set to diverge. The best performers are expected to be modern logistics facilities that are fit-for-purpose. The worst performers are expected to be legacy assets that are at risk of obsolescence. The case for logistics remains strong but it is changing.

1 CBRE Investment Management, forecasts as of Q3 2023.
2 CBRE Investment Management, forecasts as of Q3 2023.