Industrial properties have been a top-performing real estate sector but, though still early, COVID-19 could cut into returns, according to a recent presentation to CalSTRS officials.
Warehouses in the U.S. earned 13.4% in 2019, the only sector to produce double-digit returns in the NCREIF Property index, according to data from the NCREIF data. The second highest-performing sector of NCREIF Property index was office with 6.6%.
While hotels have been the hard hit by the coronavirus, the industry recently is beginning to see "chinks in the armor" in industrial properties, especially those in the port market, Taylor Mammen, a Los Angeles-based senior managing director based in at consulting firm RCLCO, told the CalSTRS' investment committee on March 4.
California State Teachers' Retirement System, West Sacramento, has a 13% target real estate allocation, with $34.2 billion invested in real estate as of Sept. 30, according to its latest semi-annual real estate report.
A combination of factors, including new warehouse construction and "drastically increasing rents" added to problems warehouse tenants have had with reduced cargo from China — are causing warehouse users to question whether they need more warehouse space, Mr. Mammen said. The coronavirus is starting to impact the price buyers are willing to pay for warehouses, he said.
Overall, investors should expect "less than ideal investment outcomes" near term, with distress for every property type in all locations as a result of the coronavirus, said Christy Gahr, principal at Meketa Investment Group. The hospitality sector has already been impacted by travel restrictions, including business cancellations and a drop in demand for leisure travel. She expects the hospitality sector to post negative returns in the next quarter. Other real estate sectors including industrial could post lower returns in the next six to 12 months.
Within the industrial sector, e-commerce has boosted warehouses supporting "last-mile" logistics, Ms. Gahr said.
"We expect an increase in demand but that will be at the expense of large logistics centers that were already fractured," she said. Warehouses that are outside of city centers and hubbed for manufacturing would suffer further.
CalSTRS is underallocated to industrial, which has been a drag on returns over the last couple of years, but may turn out to be a positive, Mr. Mammen said.
Some 13% of CalSTRS core portfolio is invested in industrial properties, which is 5 percentage points less than the NCREIF Fund Index – Open End Diversified Core Equity. Core real estate accounted for 67% of CalSTRS real estate portfolio as of Sept. 30.
The issue for owners of warehouses is whether supply chain disruptions causes credit quality to deteriorate so tenants can't pay rent, said W. Todd Henderson, head of real estate for the Americas at DWS Group.
Port velocity is down but the sector is not dead, despite an interruption in the supply chain, which historically has been transitory, Mr. Henderson said.
COVID-19 will cause a pause in demand and impact the velocity of expansion and new leasing, he said. "But I expect that it (demand) will regain momentum as fears over coronavirus pass."