Capitalizing on intense demand for industrial space, Duke Realty Corp. is on a development roll.
As it stands now, the Indianapolis-based industrial REIT owns and operates about 149 million rentable sq. ft. of industrial properties in 20 major U.S. markets. The portfolio is ballooning quickly, though.
This spring, Duke Realty bumped up its forecast for development starts in 2018 from a range of $500 million to $700 million to a range of $650 million to $850 million. As of early April, $337 million in development projects totaling 4.5 million sq. ft. were already underway.
“As a general rule, we’ve got development going in most all of our markets right now—some more than others,” says Jim Connor, chairman and CEO of Duke Realty.
Connor cites Southern California, South Florida, New Jersey, Atlanta, Chicago and Dallas as some of the top-tier markets where Duke Realty is adding the most space. However, he points out that the REIT has developed more than 2 million sq. ft. of industrial space this year in one second-tier market—Columbus, Ohio.
Across the company’s 20 markets, e-commerce players drive anywhere from 25 percent to 40 percent of development and leasing activity for what Connor likes to call “modern logistics buildings.” Those buildings serve customers such as Amazon, Home Depot, Target, UPS, Walmart and Wayfair.
In a Q&A with NREI, Connor delves into his outlook for the industrial sector, including the role played by e-commerce, and discusses Duke Realty’s development and leasing forecast.
This Q&A has been edited for length, style and clarity.
NREI: How are you feeling about the industrial sector these days?
Jim Connor: I’m feeling pretty good. Business is really, really good. Some of my peers jinx us when they say, “It’s as good as it gets” or “It’s never been better” or anything like that.
NREI: What underlies that “pretty good” feeling?
Jim Connor: You’ve got 4.5 percent vacancy nationwide. It’s the lowest it’s been as long as anybody can remember, and they’ve been keeping records 25-plus years. We keep predicting every year that supply is finally going to catch up with demand, and it still hasn’t happened yet. Based on activity, I don’t see that trend changing. When you’ve got that low of a vacancy rate, it allows us to keep the occupancy rate in our portfolios ridiculously high. Our in-service portfolio is 97.5 percent leased [as of the first quarter of 2018], and with that you get great, strong rent growth numbers.
The challenge for us—and there’s always a downside with the upside—is we’re really in favor right now, so there’s a ton of capital chasing industrial. Even though interest rates have gone up 50 to 60 basis points in the last eight or nine months, we’ve seen cap rates on industrial compress 25 basis points, and maybe more in some cases. So, there’s a lot of competition out there.
NREI: The industrial sector has been really hot lately. How long is that streak going to last?
Jim Connor: Absent some global event that obviously nobody anticipates, I would tell you the market dynamics we’re seeing look really good for the next 18 to 24 months. That’s with the supply-and-demand equation staying in balance; even if we reach equilibrium with supply and demand, equilibrium is not a bad place, particularly when you reach equilibrium with 4.5 percent vacancy. That’s still a landlord’s market.
Nobody’s slowing down at all. E-commerce continues to be a big, big driver in our business. Those guys are not slowing down. Our traditional customers—retail and consumer products companies—are investing in their supply chains to get products to their customers more quickly and more efficiently. You’re seeing a tremendous amount of investment and modernization in that sector to help them compete with the e-commerce business.
NREI: How much more industrial activity can be supported by e-commerce?
Jim Connor: I believe, as do most of the industry experts, that e-commerce is in the very, very early innings—arguably the second or third inning. E-commerce today represents about 9.0 or 9.5 percent of total bricks-and-mortar retail sales. Most experts will tell you that’s heading to 20 percent.
So, if it heads to 20 percent, that would tell you there’s a lot of runway for industrial. It doesn’t mean that all of the e-commerce deals that we’ve done in the last 10 years, we’re going to double that square footage. But it means there’s a lot more demand for e-commerce facilities, whether it’s for pure e-commerce companies like Amazon or Wayfair, or whether it’s this new generation of e-commerce food companies like Blue Apron, or whether it’s existing retailers and consumer products companies that are investing in the supply chain to better support their e-commerce efforts. The logistics sector looks very, very bright for the next several years.
NREI: In light of the demand you’re foreseeing, are you leaning more toward development or acquisitions? How does that play out in terms of adding supply to meet demand?
Jim Connor: We’re kind of blessed. We can do either/or, or in some years we do both. The vast majority of our capital and our time and energy today is going toward new development, both build-to-suits and speculative, because it’s much more lucrative for us. We’re developing projects that are probably 200 to 250 basis points higher in sustained yields than on the acquisition front. We’re very, very focused on the development side.
NREI: What are you projecting for leasing?
Jim Connor: In 2017, we did about 23.7 million sq. ft. of leasing, which was a phenomenal year for us, one of our best ever. In the first quarter of 2018, we did just under 7 million sq. ft. Ours is not a perfectly linear business, but based on first-quarter activity, our expectation is to meet or exceed last year’s leasing volume, which would put us in the mid-20 million-sq.-ft. range and would be another phenomenal year. With occupancies so high across all of the markets, until you create some softening in some of the markets—either a pretty dramatic fall-off in demand or a bunch of oversupply—I think you’re going to continue to see very, very strong numbers in terms of leasing and rent growth that industrial owners are going to put up.