The Changing Face of Industrial Properties

BRG – JPMC – Change Maker Clip 1 – Transcript

Matt:

Well thank you everyone for joining us today. We're very excited to be in the speaker series to dive into the industrial sector. We have two great guests with us today, and it's my honor to introduce Dave Harrison who's president of VanTrust Real Estate. Dave is a friend of J.P. Morgan. He has 30 years of experience in commercial real estate and a very long resume of successful projects. He's helped build up BTRE into the successful leadership position it has today, a very well-respected firm. And although BTRE is very nimble in all major asset classes, they've been very focused on industrial, both build to suit spec for their own account, and also third-party fee developer for others. So, Dave, thanks so much for being here today. Alex.

Alex:

Great, thanks Matt. Today I'm excited to also introduce Jim Galovan, a partner from the global investment management firm PCCP. PCCP has been providing debt and equity capital solutions across the U.S. for over 25 years. And Jim has played an integral role in the growth of their industrial business. From an investment perspective, what do you like about the industrial asset classes, I guess compared to other asset classes you can invest in today?

Jim:

Well, thanks Alex. It's nice to be with you all today. I'm glad to be a part of this. It's fun to talk about industrial because it is such a great asset class right now. And what do we like about it? I mean, liquidity for industrial product is greater than we see in any other asset class. And just as a bit of backdrop: the perspective that I'll bring here from PCCP’s perspective is that we actually participate in all four primary real estate product types. So we invest in office, we invest in industrial, multi, and retail. We do some hotel and family for rent housing also. So we're, it's really five or six major real estate product types that we invest in, and… But really looking probably over the past three to five years, it's been industrial, probably more than anything else right there with multi where we've spent our time and invested our capital. And what we like about it is when I compare it across the asset classes, it is the most liquid.

Alex:

That's great. Dave, how about you?

Dave:

Yeah. To piggyback on what Jim said about the different product types, those are the silos that we historically have developed in. And really, when we looked at the different filters we use on what we develop, it's been consistent for over a decade. And the filters we run projects through or what kind of product type are they, what's the geography, what's the project size. And then lastly, what the gestation period is for the project, from the time we commit to the time it can be stabilized. And industrial fit that last slot real well, because we typically looked before the steel issues and delivery issues today, we used to be able to say, you could start and finish an industrial building within a year. And if it were spec, you'd plan to deliver it, stabilized within another year on the outset. So that gestation period had us as a hedge against interest increases, interest rate increases that haven't materialized. But that industrial component was about 20% of what we did. Today, that 20% is now 70%. And it's really driven, as Jim mentioned, by the demand side.

Matt:

Dave, that’s very interesting because I'd love to be able to double click on what you said about e-commerce trends, accelerating pushing the demands higher on the outside, and also pushing record levels of supply in the country that are matching absorption rates. And so I'd love to get your take on how sustainable is that, especially with the just-in-case inventory compiling onto the demand.

Dave:

Yeah. You know, the old just-in-time model's gone. And I think with COVID, the process or the pipeline for the acceleration of e-commerce has exponentially accelerated. So whether-- we just delivered last week a pretzel manufacturing company facility. E-commerce still has an inordinate amount of market share yet to be realized. It clearly has been accelerated by COVID and everybody’s behind the eight ball from a delivery standpoint, as far as the users are concerned. And what's really being compounded as a challenge to that insatiable demand is material delivery.

Alex:

And Jim, I'd love to get your perspective on that same question.

Jim:

Yeah, I would say the way... our focus has been speculative development of new class A product and industrial, and in particular product that is well suited for e-commerce users. And so you start talking about features like trailer parking and clear height and things that are particularly important to that user base. And what we look at is the fact that really since 2010, well if you look at the industrial stock across the whole United States, only 11% of that was built since 2010. You know, most industrial buildings have been around forever for decades and decades before that point. Even though it feels like we're building a lot right now, when you put that in perspective, it's only 10, 11% of the national industrial stock. Yet in the trailing 12 months, 45% of the industrial demand was e-commerce driven.

And so there's just so much of the demand has a thirst for product that probably 90% of the stock doesn't really serve. They can go into an older building and make it work, but it really doesn't provide the primary bells and whistles that they're looking for. So, given that, it used to be that industrial demand was very much a function of GDP. GDP is up, demand is up, GDP is down, demand is down, and now you really have two demand, right? You have GDP, and then you just have supply chain reconfiguration and e-commerce and all, and that demand driver. I agree with Dave, that feels like it's somewhat uncorrelated necessarily with GDP growth or (inaudible). It'll move somewhat with that, but even in a slow economic time, you're still gonna see companies need to adjust to the changing face of how goods get delivered and processed. So we like that as a dual demand driver in the market. And I don't, I'm not smart enough to predict how long that's going to last, but it does feel like a long-term trend, not a short-term phenomenon that we're experiencing.

Matt:

And Dave, is that what you're seeing at BTRE?

Dave:

You know, it is, probably the unique situation we have right now is what starts out as a spec real quickly turns into a built to suit, even in some cases before it's out of the ground. And to Jim's point about the timing and the need on the part of the users, the last four buildings we've delivered, three of them have converted really from spec to a built to suit halfway through construction or at the beginning of construction. We just had a 660,000 square foot building be sold to an owner user on manufacturing. And before we were done with the building, they had already taken 130,000 square feet of slab out to do under-slab plumbing. So it's… the line between spec and built to suits blurring because of the delivery schedule and material procurement.

Alex:

Drilling down a little further on that. So as a developer or an investor looking to… looking for pockets to invest in, you think about life science and it tends to cluster… even office and creative office where it would cluster around other large companies, Amazons, Googles, what not. Do you see the same thing with industrial as you're looking to make an investment and hoping that maybe what was spec might convert into a build to suit? How do you think about geography and location as it relates to your investments in industrial? And maybe Dave, if you want to start with that.

Dave:

Sure. I think from an underwriting standpoint, you have to assume it's an empty building and that it is speculative. And you gotta, as Jim mentioned, all the requirements of the built to suits today, you gotta create an attractive of a mousetrap as possible, so that the site plans that we're doing today on a spec building mirror what we're learning from the build to suit requirements. And forget the-- or in addition to the labor studies and and traffic and logistics, these individual site plans on a speculative basis have substantially more expansion capabilities, more trailer storage, more circulation, more employee parking than a normal spec would’ve had even five years ago.

Alex:

Jim, are there emerging areas to sort of follow on from what Dave just mentioned and those dynamics, are there catalysts in certain parts of the U.S. that that might drive to more success in industrial looking forward?

Jim:

I think so. And I think it's an interesting question because you mentioned, maybe life science on the one end or office clusters, and there's a few of those, not a lot, right? There's four or five really strong kind of core clusters of life science throughout the U.S. On the other end of the extreme, you could say there's apartments everywhere because it's shelter and everyone needs shelter. Every little town, every small town across the country needs some form of living. And so industrial, I think, is moving actually more toward where it's quite dispersed, right? Because the industrial product is needing to go to the population centers and not just be concentrated in Chicago, LA County, and Northern New Jersey. It used to be maybe you were, you'd have one big thing in the Midwest, and then you have an outpost on either coast. And really, with just in time, just in case, next day delivery, it just doesn't allow for that model to work anymore, which is pushing industrial buildings out. So we're a national investor and we look across the entire U.S., and we're in a lot smaller markets today than maybe we thought we would have been in a decade ago.

Alex:

How do you, I guess, how do you think about the speculative deals that you're doing, of where kind of a musical chairs, is there any concern that the music could stop for industrial, and then you have some empty buildings for awhile?

Dave:

Every night I think about that. You know, there's a lot of folks in our product type right now. And with compression of cap rates, it solves all kinds of misses that somebody might have. I do worry that at some point, I'm going to wake up and somebody's not going to have an industrial site anymore; they're going to have farm ground again or an empty building. I just hope it's not us. So I think… we love good competition. I think this product type is attracting a lot of participants that, when there's movement in the other direction might not fare as well. We've got more ground now than we ever have, which bothers me as well. But the objective that we have is velocity of taking raw ground to being pad ready. And again, when we look at that gestation period, we don't want to look at ground in a 5, 7, 10-year time period, even in parks. We want to look at it at 1, 3, and 5-year periods.

Alex:

Jim, any thoughts on the same topic?

Jim:

You know, I think there's a big trend to go big, go big, go big right now with boxes cause there's been demand for large spaces. But when you're doing that in locations, that really historically haven't seen those size tenants, you might get an Amazon deal on another one, but I don't think you're five deep in a lot of these locations where we're seeing big, big bulk product. And so I think matching your-- the size of building with the size of tenant that's common in that market. It seems really obvious, but we've seen some mismatches there where I think there could be missteps if there's a slowdown.

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BRG – JPMC – Change Maker Clip 2 – Transcript

Matt:

We can all agree that innovation really has touched every industry no matter where you are. And industrial is no different, right? And so as we think about the future, I just would love to get your take on how do you see innovation, anything special that's going on on some of these buildings as owners, whether it's a build to suit or as you look to see where the market's going in the future? On our side, we've been doing a lot of these types of financing. Sometimes we see multi-story industrial. Sometimes we see very, very high per square foot improvements going in via robotics, electronic sensors. Dave, what are you seeing as far as innovation in these buildings?

Dave:

You know, when we look at the dollar amount of a total project now, that shell site work land is a minority component of the finished product, with the guts of these buildings having more value than the shell. I don't know how a light bulb works, so you don't want to ask me about the technological components of what's going in these, those are folks in my office. But in the future, we're... this took place in the office over the last couple of decades. The big push was design an office building from the inside out. And on the industrial side, you used to just do a bunch of big rectangles and then they’d fill them with something. Now it's-- we're to the point going forward that so many of these buildings are being designed from what's going in them and from the inside out more so than ever.

Matt:

What is some of the ways-- and Jim, it'd be great to get your take on this in addressing some of the environmental issues. We hear a lot about ESG, right? How do you factor that into some of the developments that you're looking at?

Jim:

I mean, what a hot topics that really is. It comes up in almost every investor meeting that we do. It comes up, it's coming up increasingly with users as our operating partners are out responding to RFPs and meeting with users. So, I mean, I would say we're certainly not as sophisticated as many groups, but we're a lot further along than we were two, three years ago in this space. And the key for us right now is really measuring what we're doing across our portfolio so that we can benchmark and then be able to improve upon those benchmarks on our new buildings. And so we look at, of course, we look at utilities, right, efficiency of utility usage, and whether there's ways to incorporate solar, incorporate tankless, incorporate innovation on the utility side that can help us be more efficient.

That's one big change, we're measuring that now and we're quantifying it. And when we look at a new deal, we actually have an ESG checklist that we go through on every deal, that's a part of our transaction summary, that's approved by an investment committee and it's sent to a lender to demonstrate sensitivity to these things that really, probably three or four years ago, weren't talked about in an investment committee and they're talked about today. Another thing we have is just, we have sort of this risk dashboard that we look at that evaluates locations based on kind of natural trends that we're seeing in the environment, whether that's hurricane, tornado, fire risk, things like that, that really factor into account, as much as we can tell, changes that are happening and in the climate and the environment to affect site selection and how that might... a location that might've looked relatively good a few years ago, now it might rank lower. And that's not the only factor, but it's a factor that will go in to make an investment decision on where we go, is really considering the impacts of the changing climate and temperatures and things like that, and how that affects site selection. That's also an area where it's come into play with us in our investment process.

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BRG – JPMC – Change Maker Clip 3 – Transcript

Alex:

I'm going to ask a question regarding the future. So, a couple of themes that we've heard, obsolescence, that that's one driving factor to the opportunities that we're all seeing in industrial. There's a lot of obsolete buildings out there and so we need to improve those. Then this transformation that's really being driven by e-commerce is another big factor. So here's your crystal ball opportunity. You know, we've seen this big transformation over the past 10 years or so. As you look 5 to 10 years down the road, where do you think we might be? Is there a possibility that the buildings you're building today could be obsolete 5 or 10 years from now? Or is what we're building today going to be kind of the new normal go [sic] forward and there'll be slighter adjustments, but there's not going to be as large of a transformation? Either Dave or Jim, feel free to jump in on that one.

Dave:

You know, I can drive about two miles from my office into the garment district in downtown Kansas City. And a hundred plus years ago, there were multilevel warehouses and manufacturing. It's taken us a hundred years to get back to that. We're seeing it again. I-- when we look at the obsolescence potential for what we're doing today… And just go back, Alex, to your last 10 years. We've had site obsolescence in product because of parking and trailer storage and circulation. The other giant obsolescent component is ceiling height. What was 14 went to 18, went to 24, 32, 36, 40, 60 now. Jim, you might have some taller than that. I don't know where it ends from a obsolescent components standpoint. But 10 years from now, we're not going to be building the buildings we're building today. I just don't know what they look like.

Jim:

Yeah, I'm with Dave. I mean, the rate of change is so fast in recent years, it felt like maybe industrial was in a time warp for a long time there until e-commerce where the buildings didn't really change materially from maybe the seventies to the eighties, to the nineties, to the, you know. But now we are in an age of such innovation on how product gets moved and delivered. And so I almost think more about, I mean I just think we're not smart enough to predict the product in 2030. But we probably have a decent sense of the locations that'll still be relevant, you know? So if you can do, that's where I would maybe lean a little bit more on location than we would on, "Hey, we have the perfect product." If we are building for a long-term hold, with that mindset, hey, I want this thing to be relevant when my 10 year lease burns off.

Is it going to work in year 11? I think it's location first cause that I think is going to have less variability than the box itself. And then it's probably just the, think about access, think about circulation. I mean, I think those things would probably always be important. Can you get around, can you get into it, can you get out, how far to the freeway? Some of those fundamentals more than trying to predict, is my rectangle going to be the right rectangle in 10 years? It won't be, but we can't tell you why it won't be. So that's, I don't have that good of a crystal ball.

Alex:

Well, that makes a lot of sense. And folks like yourselves that have been in the business a long time and you've seen a lot. You're in the best position to really adapt and to lead us through this. So Matt, I think we are getting close on time. So listen, we've learned a lot today from both of you. Clearly, there's no shortage of opportunity now, and it seems in the future with industrial. While the industrial sector continues to evolve, we trust both of your firms will be on the forefront of change, creating values for these tenants and your investors like. So on behalf of J.P. Morgan, Matt, myself, we'd like to thank you both for sharing your views with us today. We sincerely appreciate your business and we intend to be there for you over the long term. So thank you again, we really appreciate it, and good luck with everything.

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