Episode #14 - Q1 Update for 2020
The Industrial Advisors take a look back at the first quarter of 2020 amidst COVID-19 and share their thoughts for the year ahead.
Voiceover: Hello and welcome to another great episode of the Industrial Advisors podcast. Matt McGregor and Bill Condon are your hosts, and each week they bring you important information to make your life easier as a corporate real estate people, tenants, landlords, capital market investors, brokers, and developers of industrial real estate.
Matt and Bill's objective is to teach and advise on everything about industrial real estate and supply chain. In this episode, Matt and Bill outline what has been a strong first quarter despite the devastating effects of the COVID-19 epidemic. Today, you'll hear some of the great news from these challenging times.
Yes, companies are still leasing space and growing. This is going to be a powerful and informative episode. Now, here are Matt and Bill.
Matt McGregor: Well, hello everyone. Thank you very much for tuning into The Industrial Advisors Podcast. This is Matt McGregor, and you've got Bill Condon here, your host. This topic, I think this is episode 14, Bill, our Q1 quarterly update. We're going to take a little different spin on this, only because clearly with the COVID-19 situation out there, everything that is of interest to the listener needs to be brought in through the scope of the current situation. So, we'll do our normal updates, tell you guys about what the numbers were in the first quarter, but we're really going to talk about what the situation is out there in the marketplace right now, and how we see this playing out in our marketplace over this next quarter and beyond. Let me just start out by apologizing for the audio sound. This is our second podcast via quarantine. So, both Bill and I are calling into this, and we appreciate your understanding of the quality. Bill, how are you doing?
Bill Condon: Doing well, doing well. We're all quarantined up. Kids are homeschooling, and we're taking it day by day. I hope everyone out there is staying healthy.
Matt McGregor: Yeah, I guess I should apologize not for the sound quality, but for the kids that are probably going to be running into your office throughout the show.
Bill Condon: Yeah. I sent Jenny a text saying, "Hey, keep the kids downstairs for the time being."
Matt McGregor: Very good, very good. Well, let's just start off with Q1 kind of statistics. Actually, despite everything that's going on, we've done a lot of leasing, Bill. Amazon's taken in this first quarter just about 1.4 million feet in the greater Seattle area. Then, you combine that with a couple other large deals that were signed. Schneider Logistics for 168,000, TTE Logistics for 116, and then the big one that got signed, 1.3 million feet in Lacey with Home Depot. Although that one is under construction, this is all going to be ... You add those all up, and we're at about 3 million feet of positive absorption just on those deals, Bill. That is greater than our normal annual absorption average over the last about five years at about 2.6 million feet a year.
Bill Condon: Yeah, it's the best first quarter from a leasing standpoint that I've seen since I've been in this industry. Certainly, there were some big deals that were done, but there was a lot of deals in that 100 to 150 range, which is really the bread and butter of our market that also got done. So, first quarter from a leasing standpoint was extremely strong. Obviously, second quarter is going to be a lot quieter, given circumstances, but Q1 was outstanding from a leasing standpoint. Capital markets, however, which is typical in the first quarter, given the huge fourth quarter that we had last year, we had a slow Q1 on the capital market side. Where do you think that's headed, given the current environment?
Matt McGregor: Well, to your point first of all, Q1 is always slow on capital markets. But, predictably we already had said it was going to be maybe record slow, because we had a record 1.5 billion of industrial transactions in 2019 with 600 million, just over 600 million in transactions in December alone because of the increased excise tax that was hitting Washington State. So, anybody that was going to do a deal in the first quarter was trying to cram that deal into the fourth quarter, right? And, so we predicted that this was going to be one of the worst first quarters we had seen. That all being said, we did do about 110 million in this first quarter with a couple transactions in January and February, zero of course in March. And, we're not anticipating a lot moving forward. So, to your question now with that background Bill, certainly we're in unprecedented times. You've still got a lot of capital out there wanting to find a home, mostly with a really rocky stock market.
Matt McGregor: You've still need a lot of buyers out there, but they're waiting for repricing, quite frankly. And, a lot of the deals that were under contract are extending and/or being put on hold, because both buyers and sellers aren't sure where this is going to price out. We don't have comps to go on. Guys are saying, "Gosh, should I be buying this at a record price? Or, is this going to follow the trend of the stock market?" And, because transactions aren't happening with the stock market, you can just watch it and go, "Okay, it went down 15%." it makes sense with real estate. You don't exactly know without deals happening, how to price it.
Bill Condon: Yeah, I would agree with that. I mean, even in one of the best markets in the country like we have here in Seattle, most of the institutional groups that we're talking to are hitting the pause button to see how these next ... I think the second quarter, Q2 is going to be a quiet one as most groups are going to be looking at, what is the new market, right? And, really watch as things progress, but I think Q2 is going to be slow, as again, the majority of the groups are just, quite frankly, on hold.
Matt McGregor: Yeah, I think at least for this second quarter, and probably obviously the third, people are waiting to see how the companies within the industrial assets that they would be purchasing are going to weather this storm. Are the rates they are paying going to hold up as there are going to be blend and extends, and redos of leases, and rent abatements to assist companies getting through this. How does that then impact value of real estate? So, we've got a lot of unanswered questions, which to your point is going to keep capital markets a little bit slow for the next couple quarters as we try to figure out a new equilibrium here.
Bill Condon: Yeah, we have about six million feet available that's under construction right now. What do you think is going to happen with those buildings that are currently under construction?
Matt McGregor: Yeah. Luckily for this market being the greater Seattle, Washington area, to your point, we've got 6 million feet. About 4.2 million feet of that is available. We really aren't over built. I think the developers here, the woes of 2008 and the great recession, we're not so far in the past that they don't remember. So, I think the developers were careful not to overbuild. Although 4.2 million square feet sounds like a lot available, it's really not. We had 10.3 million feet delivered over the last 24 months with only 1.7 remaining, so very, very good absorption. I think with the boom of e-commerce, I don't think we have too much. I think obviously you're going to have some retailers slow down. But, I think with the e-comm boom that's happening right now, that we're just fine, and that we certainly are not overbuilt. I wouldn't be surprised if a lot of this got absorbed through the shift to e-commerce.
Bill Condon: Yeah, to that point, what I've seen from tenants, a lot of the mid-size tenants, some of the smaller tenants are hitting the pause button and trying to buy some time. But, the bigger tenants that are out there still seem to be committed to doing deals. To your point, the e-commerce trend is clearly going to continue at a higher rate.
Matt McGregor: That's a good transition point, Bill. So now, we've got Q1 behind us. We've seen those numbers. We're in pretty good standing, given a horrific situation with COVID-19. Now what? Let's talk about that. So, where we're seeing the demand, we're seeing a demand absolute drop in brick and mortar, which represents over 85% of the US retail sales pre-corona. So, you've got nobody going to malls. Malls are closed. You've got nobody going to retail. Retailers close, so they're shifting to e-commerce.
Matt McGregor: So, what we're seeing is just an explosion of distribution, e-commerce, online for medical supplies. Food and beverage is obviously booming, and you've got a massive need for temporary overflow. But, I'm talking huge square footages, because all of the supplies that were ordered from Asia, whether it's your shoes, your coats, your furniture that was coming in, it was too late to cancel that. COVID-19 came on too fast, so you have all these supplies coming in with no retail sales for it. It has to go somewhere. So for example, a well known shoe company needs 5 million feet of overflow storage for the next year, because of all these shoes coming in from Asia.
Bill Condon: Yeah, 5 million feet across the country, and I think we're going to continue to see those bigger short term requirements. Landlords are willing to do ... Two months ago, landlords weren't going to do a short term deal in our market, right?
Matt McGregor: That's right.
Bill Condon: Now, most landlords are absolutely willing to play ball, and in particular on the larger requirements. So, I agree with you. We're going to continue to see a demand for big chunks of space for short term requirements. Then, of course renewals, right? Leases expire, and tenants have to renew, or they have to relocate. What do you think from a renewal standpoint that looks like here in Q2?
Matt McGregor: We're seeing a lot of renewals and early renewals. It does remind me of that kind of 2008, '09, '10, '11 time where tenants were having a tough time. So, they were reaching in for some relief in those terms, blend and extend, and rent deferment, and things like that. You're seen a lot of renewals right now looking for some upfront concessions related with free rent, and/or a combination of that and reduced rent, and/or deferred rent. So, if somebody has 15 months left on their lease, they're not going to wait. They're going now to the landlord and saying, "Hey, how about a new five or seven year deal?" And, they're getting a few months of free rent upfront in order to get through this situation. We're seeing, to your point, a massive amount of renewals. The normal renewals that say were within that eight month timeframe, but you're seeing people stretch out to even up to two years or so, early renewals happening. So, those deals are happening. Again, we saw that, didn't we, Bill? We did a lot of those right when the downturn started in 2008.
Bill Condon: Yeah, and I think this go-round, landlords are really playing ball earlier than they did last time, because a lot of the new deals that were out there in particular with mid-sized companies, smaller companies have really been put on hold. Again, we're seeing that the larger companies continue to see their deals through. I think that will continue, but a lot of 100 to 150s have been been put on hold for the time being.
Matt McGregor: That's right, and you're seeing a lot of landlords to your point, that they're playing ball. They're dusting off those applications that they used in the downturn to reassess a firm's credit, their business plan, how they're going to get out of this in an effort to meet them in the middle with some sort of rent concessions and rent deferment, making sure that they're right-sizing their company, or their business plan is going to get them through this tough time, and making sure that partnership is going to be there for the long haul. But, we're seeing a lot of those, to your point.
Bill Condon: Yeah. The hard part right now, I think for both landlords, and tenants, and brokers as well, is figuring out what's market from a rate standpoint. There's not a lot of new deals getting done right now, so you don't have a lot of data points. But, figuring out what market rents are is a bit challenging right now, wouldn't you agree?
Matt McGregor: Well, yeah because you've got a lot of deals that were at the goal line that are now on hold, or the tenant is just trying to go back to the landlord with massive repricing, but without a lot of comps. We'll get into that. It hits capital markets as well, but you don't have comps. You don't know where we're going. To my point earlier about the stock market, you can look at it, and you know exactly what happened. Well, with rates, we don't exactly understand the total repercussions of this situation. So, we don't understand. Okay. We were at, say 72 cents on an agreed-to deal. Well, does that mean because the stock market went down 26% that the rate goes down 26%? Some people make that argument. I don't think that's a sound argument, right?
Bill Condon: I don't either.
Matt McGregor: So, is there a discount? Is it there? I think landlords are playing ball, but I don't think it's exactly in line with the stock market. And, we're not seeing enough deals done, long term deals, to get a feeling for a big rate drop. We're certainly seeing a drop a little bit, but I think to your point, all these deals are put on hold, so we're just not seeing as many transactions to be able to get our hands around exactly what kind of rate drop we've seen.
Bill Condon: That's right, and I do really think that landlords have stepped up to play ball with the right tenants. A lot of these institutional landlords treat tenants like they're their customers. So, I do believe that we are going to be some short term renewals here at Q2, maybe into Q3 where there's not probably going to be a lot of 10 year deals done, but we may see a few one to three year renewals take place as both sides are trying to figure out what's going to play out here over this next year or so.
Matt McGregor: Yeah, I do think we'll start to get our hands on a lot of comps, and obviously we're doing a lot of them on the renewals. They are term deals, because guys are trying to get a lot of free rent to kind of get them through this. But, we're seeing a lot of those temporary deals that we'll start to understand rates through that as well. And, you're seeing a boom on the 3PLs out there with those deals because of the e-comm. So, I think another month, another six weeks from now, and we'll have a couple dozen good lease comps to start to see that trend, and to be able to say on the next podcast, "Here's exactly what happened to rates." But, it's only been four or five weeks now since this whole thing really hit the US. So, we just don't have enough data points to point the listener, whether you're a tenant or a landlord to say, "Gosh, we're down eight percent." But, I think in the coming weeks, we'll be there.
Bill Condon: Yeah, so to recap a little bit, Q1, phenomenal on the leasing side, very slow as predicted on the capital market side. Q2 will continue to, in our opinion, be very slow from a capital market standpoint as we figure things out over the next 90 days. We do however think that the deal velocity on the leasing side, we'll be okay through Q2.
Matt McGregor: Yeah, I think e-commerce is going to save us. We're seeing a massive growth in US e-commerce. I mean, my dad who doesn't even have a cell phone actually ordered groceries online the other day to stick with the quarantine issue. I'm like, "Dad, you've got to get a cell phone." He's like, "Hey, I ordered groceries online." So, people are figuring this out, and you're going to see up bunch of e-commerce deals done because of this growth. I think you're going to see the amount of ... If COVID-19 didn't happen, I would say you're going to see in 2020, the amount of e-commerce deals done that would have taken us three to five years to do, because everybody was forced to figure out how to get stuff online.
Matt McGregor: I said it in the last podcast. I'll say it in this one. In 2019, 11% on average of US sales were e-commerce versus brick and mortar with a surge in December, in the Christmas time to 14.6%. In comparison, in 2019, China and Korea combined average 44%. Again, this is pre-corona. So, US had, even though everybody thinks, gosh, you come home, and you've got a stack of Amazon boxes at your doorstep. Primarily, predominantly, I should say the US was still brick and mortar. It's not going to be that way in 2020. We're going to have a massive influx of e-commerce even past COVID-19, because people are going to be a lot more comfortable with it. So, we're going to see those deals in Q2, Q3, and Q4 filling up industrial space and making up for a lot of the other smaller deals and brick and mortar type distribution deals that got put on hold.
Bill Condon: Yeah, I mean for those late adapters to the e-commerce side, folks like your father, and once you start doing it, the convenience factor is there, right?
Matt McGregor: That's right.
Bill Condon: That percentage is only going to go up. Well, we want to just a recap and thank everybody for listening today. We miss seeing everybody. We hope that everybody stays healthy, and please do feel free to reach out to either one of us should you have any questions about where the market is, where the market's headed. But, again, please stay safe, and we'll look forward to hopefully seeing you guys in the near future. Take care.
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