Industrial Investment’s Changing Risk Picture: DWS’ Todd Henderson

Todd Henderson, Head of Real Estate Americas, DWS Group. Image courtesy of DWS Group

Benefitting from robust demand, very low vacancy and increasing rents, the industrial sector continues to be the darling of commercial real estate. The latest CommercialEdge report shows that tenants are paying increasingly higher rents for a diminishing amount of available space. National in-place rents for industrial space averaged $6.95 per square foot in October, up 580 basis points year-over-year. Meanwhile, the national vacancy rate clocked in at 4.0 percent, unchanged from the previous month.

To find out more about where the sector is headed, Commercial Property Executive reached out to Todd Henderson, the head of the U.S. real estate investment business at DWS Group. The company has more than 45 million square feet of warehouse and distribution space under its U.S. portfolio, according to the same data provider. Henderson provided his views on the industrial market, pointing out potential risks.

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How is DWS addressing oncoming headwinds such as rising inflation, the surge in borrowing costs, and the overall slowing economy?

Henderson: We are taking a defensive posture and focusing our efforts on the sectors that have the best fundamentals, limited capital expenditure requirements and stable cash flow. The industrial and residential sectors are best positioned to meet our current risk appetite. While these sectors are not immune from the capital markets dislocation caused by the rapid increase in interest rates, they both benefit by having historically low vacancies and structural demand generators that should persist through slowing economy.

Are there any lessons learned during the past few years that can serve investors today?

Henderson: The pandemic was the great accelerator. Several macro trends that predated the pandemic picked up significant momentum throughout the pandemic. For example, population migration to the Sun Belt states, supply chain redevelopment, and the retail real estate reckoning all gained speed throughout the pandemic. These trends were not brought on by the pandemic but accelerated because of the pandemic and now, in the post pandemic era, are still relevant. Much of the pandemic-induced stimulus is gone or systematically being removed from the market through central bank tightening.

Image by Pexels via Pixabay.com

Is there anything brewing that could undermine the industrial sector’s performance, especially since various companies are delving into onshoring options?

Henderson: The industrial sector continues to enjoy historically low vacancies, escalated rents and strong demand. Several factors are driving the demand for industrial real estate. Long term e-commerce growth and omnichannel retailing continue to drive retailers to build out their supply chain with distribution and fulfillment centers. The desire to create supply chain security and resiliency is resulting in strong third-party logistics demand. And inventory rebuilding in certain sectors of the economy is supporting demand.

Despite the escalated levels of construction of warehouses over the last several years, supply has steadily lagged demand. The risk is that demand will slow and the current wave of new supply will outpace demand causing an increase in vacancies. However, our projection is that, even if this happens, industrial vacancies will settle below historic averages. Therefore, the downside case for industrial at the moment is more of a reversion to the mean.

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What types of industrial assets are in high demand in the current economic landscape, and which are seeing less demand?

Henderson: Industrial assets generating the highest demand are modern, newly constructed warehouses in close proximity to large population bases. However, throughout this industrial cycle, when faced with a choice, tenants have chosen location over building improvements due to the demand for labor and the cost of transportation from longer distances.

Is DWS considering any markets to target the preferred subclasses you just mentioned?

Henderson: We cover approximately 26 markets. We have chosen these markets through the examination of factors that drive and sustain value. Of our 26 markets, not all are investable at the moment. However, the high population and job growth markets throughout the Sun Belt states and the Mountain West remain targeted investable markets for our industrial and residential strategies.

What were the high notes of 2022 for DWS’ industrial arm?

Henderson: We have delivered strong outperformance for our clients throughout 2022, in both our core and development portfolios. During the first half of the year, we delivered a total return of approximately 23.8 percent, beating our benchmark by approximately 700 basis points. In the third quarter, as the cost of capital increased, the portfolio held value due to the strong rental rate growth quarter over quarter.

What should investors keep in mind regarding near-term risks for industrial investment as they strategize for the months ahead?

Henderson: The two biggest risks in the market today are a continued increase in the cost of capital and the potential for demand destruction as a result of Fed-induced recession. The irony of the market risk today is that further good economic news in the short term could exacerbate both the cost of capital and the magnitude of demand destruction.