Which Industrial Real Estate Sub-Sectors will Survive the Pandemic?

While the COVID health pandemic might have accelerated demand for many industrial spaces, the industrial property market does not operate in a vacuum and the challenge for the sector will now be twofold: navigating an increasingly competitive market for industrial properties and understanding which sub-sectors will have the most staying power into the future.

Of the recent industrial sub-sectors to emerge, last-mile delivery and big box distribution centres became the most recognized. While e-commerce growth shows no signs of slowing down globally and will fuel demand to occupy these properties, the supply will eventually plateau due to the limited number of suitable sites or suitable tenants. When these modern industrial buildings are sold, capitalisation rates can be expected to be low as investors with exposure to other asset classes jockey for a very limited number of these deals.

The physical attributes of many industrial properties impact pricing as well. In the same quarter, Cape Town industrial properties with ceiling heights of at least 10 metres traded for an average of R65 per square metre, or approximately 23 percent higher than properties with lower ceiling heights. Similar trends were noted in other parts of the country. The reason for the growth of properties with height is due to modernised racking and storage systems that require height. Trends such as lower demand for office space have weakened properties with high office: warehouse ratios. While demand for warehouse spaces with large yards and outdoor areas have grown recently as supply and logistics sites have grown in demand.

Over the last year demand for vacant industrial-zoned land, or what is known in the USA as IOS - industrial outdoor storage - has grown particularly in the second half of 2020. Due to logistics companies wanting highly secure places to park trucks industrial sites, with facilities for drivers, has surged. Rental rates for yards have increased by 20-25% in certain industrial suburbs.

Other, industrial spaces are attracting demand as well. Across the world the pandemic has spurred increased demand from government agencies, health care providers, and nonprofits to acquire storage for essential medical equipment, non-perishable food and other emergency supplies. South Africa has seen some of this and the question for many industrial property specialists is whether this will grow in the next 24 months.

While there are questions as to how much the country will stockpile moving forward, if nonprofits, health care institutions, and government bodies do shift to a mindset of over-preparation in the future, the impact on leasing demand for storage will be significant.

Demand for modern cold storage facilities is another industrial type that has grown globally. Since the pandemic, in many countries the the grocery home-delivery sector has developed into a hyper-specialised market. With new e-commerce delivery ventures such as dark kitchens and dark stores the list goes on. As these enterprises continue to expand their presence in urban area, the demand for smaller yet modern cold-storage facilities will rise.

The need for manufacturing space has also risen rapidly. A growing craft movement, coupled with political aspirations to increase domestic manufacturing and reduce dependence on other countries, has fueled growing demand for modern manufacturing space. If the “buy South African” movement takes off, manufacturing real estate startups will be well-positioned for growth reversing two decades of manufacturing declines.

Cannabis and indoor agriculture is the last trend to watch. As South African Courts ponder on the legality of marijuana production and wholesale distribution, the list of legal uses for cannabis could grow, which will impact the industrial market as it has in other countries. Because the government still classifies marijuana as an illegal drug, the obstacles to owning, financing, and insuring cannabis-based properties are substantial and, as such, institutional capital will continue to avoid the sector altogether. However, an opportunity for entrepreneurial-minded investors with a stronger stomach for risk will eventually prevail.

Certain use types within the industrial asset class will have staying power post-pandemic. Last-mile distribution, multi-let and storage will continue to thrive in a competitive market. Other uses, could see growth and less competition, but that will come at the cost of much greater risk as the market tries to get its bearings in the post-COVID frontier.