Industrial REITs: A tale of 300 markets

Vikram Malhotra
Managing Director, Senior REITs Equity Research Analyst
April 14, 2023

Real Estate  Research 
  • Industrial REITS struggled in 2022 as major ecommerce and shipping companies paused growth. 
  • In 2023, we believe industrial REITs are more attractive, as real estate fundamentals remain solid and the stocks trade at more attractive multiples.
  • Significant divergence among submarkets, however, may mean it’s a good time for large, diverse REITs. 

Industrial REITs enjoyed boom times throughout the pandemic as ecommerce drove demand for warehouse space. That ended last year, when Amazon and other major warehouse users started to rationalize their warehouse space after years of rapid growth. 

We were negative on industrial REITs last year, which turned out to be the right call as the group fell roughly 30%. However, in 2023, the landscape looks different. Today, industrial REIT fundamentals look solid and the stocks are more attractively priced — especially relative to other REIT subsectors. 

To take advantage of today’s market, REIT investors may need to change strategies. We’re seeing big variations among geographic sub-markets, with some areas seeing demand remain solid, with stronger rent growth, while others seeing a rapid deceleration. Instead of focusing on markets and REITs with a narrow geographic focus and recent strong performance, we believe this is the time to focus on large, well-diversified industrial REITs.

Demand growth is normalizing after a “2yr Pull-Forward”

Traditionally, performance in the industrial REIT space has been closely tied to the broader economic environment. Today, the macro trends are uncertain as persistent high interest rates, banking sector uncertainty, and inflation all raise the specter of a recession. Despite the macro headwinds, we believe industrial REITs are attractively positioned. 

The pandemic pulled demand forward for warehouse space to support growing ecommerce demand. Ecommerce growth began to normalize last year, with some major warehouse users reducing the size of their footprint. Some tenants are pausing growth amid concerns over an economic slowdown. Several indicators, including the University of Michigan Consumer Sentiment Index and the Advisory Board’s Leading Economic Indicator, suggest that warehouse demand will fall during the next six months. 

Even if a recession does come, we believe industrials are in a different place than they were during previous pullbacks. Today, more generalist investors hold industrial REITs, which could help support demand for these stocks even during a recession. Fundamentals are better, with vacancies lower than they were in 2007. Finally, ecommerce was not a major factor for industrial REIT demand in previous economic cycles, but could add incremental demand moving forward. 

After last year’s selloff, industrial REIT stocks are trading at attractive valuations. The headline cap rate is 4%, but rents have been rising. If you take higher rents into account, the real cap rate is closer to 6%, well above the long-term average.

Big differences exist within different markets

While the overall picture for industrials is encouraging, there are major differences in market dynamics — not just between coastal and inland locations, but also within specific submarkets of those regions. 

To understand the state of industrial REITs today, we analyzed more than 300 sub regions, assigning each a weight based on the revenue contribution to each REIT in our coverage. We then used fundamental data from CoStar to analyze demand relative to available supply, vacancy trends during and pre-COVID, new supply, and rent growth.

Based on our analysis, dispersion between submarkets is unusually high today, with sub-markets in the “top-cohort” seeing demand as a percent of availability at 10% and holding, while the bottom cohort is seeing 4% demand growth. For regions experiencing a deceleration, the outcome is caused by demand fatigue, macro headwinds, and growing supply. What surprised us in particular is the demand deceleration (relative to available stock) in several California sub-markets, e.g., parts of Inland Empire. 

Top picks for today’s market

Those market trends suggest a diversified approach for investors. The market consensus has been to focus on REITs with a strong presence in coastal markets, where rents have accelerated dramatically. However, even small changes in vacancies could disrupt that growth trajectory.

We believe a better way to play the current market is to focus on geographically diversified REITs that produce profits from both rents and developments. These diversified companies that can withstand weakness in any given market. 

Our top pick is Prologis (PLD). The company has a strong presence in submarkets that offer sustainable demand and potential upside rent growth. At the same time, the company’s private capital business gives them a lever that competitors don’t have. The stock traded at $114 recently, and we have a price target of $140. 

EastGroup Properties (EGP) is another top pick. EastGroup operates in many Sunbelt cities, which concerns some analysts as warehouse supply in the Sunbelt is likely increasing. However, our deep dive into the company’s specific sub-markets suggests that there will be more than ample demand for the new supply. Many of EastGroup’s development projects are preleased, and we believe the market is underestimating EastGroup’s potential for rent growth. The stock recently traded at $153, and we have a price target of $185. 

A strong foundation

The REIT landscape has changed, with new investors in the market, new drivers of demand, and greater dispersion between markets. Despite the macro risks to the economy, we feel the set up for large, diversified industrial REITs is strong and pricing is attractive.


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