Cushman & Wakefield’s In the Opportunity Zone: Don’t Miss the $100 Billion CRE Event details the mechanics of opportunity zones and remaining uncertainties, estimates the program’s ultimate impact, and outlines recommendations for investors on fund formation and investment strategy. For industrial-property, there is indeed untapped ‘opportunity’ in these zones – with the right strategy at play.
Last-mile distribution in urban core
Many opportunity zones are in relatively distressed areas within the urban cores of U.S. cities. Investors may want to focus on the major and secondary markets where eCommerce adoption is elevated. To the extent that there is available land, these areas are attractive for ground-up development, especially as land values will be attractive relative to alternative areas. In land-constrained markets, investors should consider redevelopment or conversion of existing structures – for example, distressed strip or power center properties.
Outlying metropolitan areas
Opportunity zones at the periphery of metropolitan areas tend to be less land constrained, making ground-up development more feasible. The issue with these properties is the lack of barriers to entry. While the opportunity zone program does not remove this issue, it does create a tax arbitrage between opportunity zone sites compared to otherwise interchangeable sites. There are a number of different product types suitable for these areas and capable of servicing the metropolitan area and beyond as: 1) local or regional distribution centers 2) cold storage facilities and 3) return centers. Also, tenants currently at infill, multi-tenant distribution (MTD) centers that do not require same day delivery may be persuaded to relocate to their own distribution facilities in lower-cost areas, especially given the rapid run-up in rents in the MTD segment. See Multitenant Distribution Warehouse Outlook blog.
Labor availability and cost have become increasingly important factors for warehouse facilities in general, particularly in some outlying areas. Opportunity zones can compensate, as unemployment rates tend to be elevated in these zones. In addition, rising housing costs in the cores of leading metropolitan areas have been driving population to outlying or exurban areas. This provides a potential labor pool for these facilities. Stockton, California, much of which is classed as an opportunity zone, is an example. The population has been growing; unemployment is 6.3%, significantly higher than the Bay Area or Sacramento; and it is well-situated to service both of these areas, connected by major rail and highways.
Redevelopment in land-constrained markets
Across a wide range of markets, industrial vacancies are well below historical averages, and in many, they are at all-time lows. Orange County, California provides an extreme example—vacancy was just 1.8% at the close of 2018. Cushman & Wakefield research has found that most vacancy across the country consists predominantly of older product. Class A vacancy in many markets and submarkets is almost nonexistent. Class B product has seen robust demand as tenants have been willing to accept suboptimal product to meet growing demand. Investors have recognized this opportunity but have also shifted to development and redevelopment strategies to meet the demand for modern space.
In land-constrained markets with the lowest vacancies, opportunity zone incentives could make the difference for an investor considering holding older product or redeveloping it–and even more so for investors already pursuing redevelopment strategies. And as it happens, many low-vacancy industrial areas are opportunity zones because of surrounding, distressed communities. In particular, there seem to be concentrations of opportunity zones around ports and airports. Examples include Oakland International Airport, JFK International, the Port of Oakland, and the Port of Long Beach. One option for these markets might be multi-level warehouse, a number of which are currently under way in capacity-constrained markets. One is being built in an opportunity zone abutting JFK. These assets have become commonplace in Asia, but it remains to be seen how they perform in the U.S. given the high and rising construction costs. Opportunity zone incentives create a greater margin of safety on these and other development plays.
A savvy development (or redevelopment) strategy accounting for the availability of land and labor, zoning, logistics and demographic shifts can be a powerful play for industrial owners and investors.
David Bitner is Head of Americas Capital Markets Research at Cushman & Wakefield. His research focuses on how macroeconomic trends, real estate fundamentals and dynamics in the broader capital markets interact to shape commercial real estate risks and opportunities for investors.