Clarion Partners acquired a closed-end industrial platform in 2002 and converted it into one of the first sector-specific open-end fund vehicles in the warehousing and logistics space. During the past 20 years, what have been the most interesting changes in the industrial sector?
David Confer: It has been an interesting two decades for industrial, for sure. The sector has become much more institutional during the past 20 years, driven by the increasing importance of the supply chain. Back in the late 1990s, warehouses were often viewed purely as cost centers, but in today’s fast-paced world, the need to move inventory efficiently has put significant strain on transportation infrastructure, and helped create more value in well-positioned, streamlined distribution networks. As the properties have transformed, so too have the investors’ perceptions of the sector, as evidenced by industrial’s shift over the past 10 years from one of the lowest allocations in the NCREIF Property Index to the highest.
John Killian: Of course, the rise of e-commerce has had a profound impact on the sector during the past 20 years, changing the way companies distribute their products. Tenants are much more sophisticated today, taking advantage of technologies such as predictive analytics and automation to identify prime locations and operate their businesses. Efficiency, location and access to labor are the new value drivers for logistics properties, leading to changes in building size and design, tenant requirements, and increased employee counts in warehouses. In addition, industrial has been a malleable product type in its ability to morph and flex and meet the needs of many types of users beyond manufacturing and distribution centers. It has evolved to meet a broader range of uses, from sound stages to cold storage to research and development, and I expect we will continue to see new and creative uses for the space.
How have investor attitudes toward industrial real estate changed over the years?
Killian: When we originally formed the Clarion industrial platform, we had to educate most investors about the sector and why it was a strong and growing opportunity. Investors were familiar with other sectors — almost everyone had used an office, residential or retail property, but only a few investors had a strong understanding of the underlying importance warehouses and distribution centers held in a rapidly expanding global supply chain. Of course, the growth of e-commerce has since reinforced the idea more obviously, leading to more interest and understanding from investors.
Andy Lowe: Fast-forward 20 years, and industrial is now a significant portion of many investors’ overall real estate allocation. That shift is happening in regions outside the United States, as well, as e-commerce adoption expands globally to a greater degree.
Industrial real estate has outperformed other sectors over 20-, 10-, five-, three- and one-year time frames. What makes industrial real estate such a sound option for investors?
Confer: High historical renewal percentages coupled with lower costs to re-tenant a facility have historically provided a nice steady cash flow to industrial investors.
Killian: We're seeing a greater emphasis on locating distribution facilities closer to population and labor availability, and anticipate a continuing premium for high-quality class A properties
What are some of the traits that attracted you to the asset class when you began investing in the sector, and are they still the same today?
Confer: The greatest attraction for me is the strong cash flow generated by this property type. Over the past few years, phenomenal compression in cap rates and growth in net operating income have led to valuation increases, but historically, the steady cash flows in the sector have been beneficial.
Killian: We like to say we were industrial people before it was cool. The industrial sector has been a low-volatility sector with low capex requirements over the last couple decades. The sector has rewarded investors who focus on the details — high-quality, well-located properties that appeal to the broadest range of users should provide a solid return over time. Although there have been changes to the business over time, we still make every investment with that core belief in mind.
How have standard building specifications changed over time?
Lowe: The biggest changes we’ve seen in building specifications come in the form of increased clear heights (with 32 feet to 40 feet now being the norm), increased column spacing, higher power requirements to accommodate material handling and warehouse HVAC, and more energy-efficient improvements, such as increased roof insulation and LED lighting.
Dayton Conklin: In addition to the changes to the interior of industrial buildings, the standards for the exterior of the space have changed, as well, with a greater emphasis on efficient ingress and egress with lower site coverage to accommodate increased trailer- and employee-parking requirements. As Andy mentioned, efficiency and sustainability features have also become an increasingly important factor in building design. In fact, all new construction across our platform is now designed to meet LEED standards.
How important of a factor is obsolescence to investors?
Confer: Given the strength of today’s market and high competition in key locations, tenants are currently forced to look past some imperfections. With nearly half of the investable universe that makes up the U.S. industrial sector more than 40 years old, however, obsolescence and redevelopment are likely to be prominent themes in the sector during the next 10 years. Tenants are increasingly requiring more modern buildings to meet their evolving needs, and there is a widening gap between rates for class A and B properties. Savvy investors will be focused on tenants’ flight to quality, as a modern portfolio is more likely to drive better long-term investment returns.
Conklin: There is no doubt that newer, more modern and functional buildings are favored by the majority of tenants in the market. Logistics operations are so much more sophisticated now, and those demands require state-of-the-art buildings.
How has your team adapted over the years to account for the changing market?
Lowe: As the sector has matured, the team has applied the market knowledge we’ve accumulated over the years to push boundaries for rent growth, often challenging our broker teams about what is achievable. Additionally, as sites within traditional boundaries of established submarkets have become scarcer, the team has succeeded in tackling more complex redevelopment programs in infill locations and identifying new locations for successful industrial developments.
Conklin: We have continued to grow our team and expand into new markets — including markets we might have once deemed less strategic — as our tenants have expanded into new areas, supply chains have changed, and populations have shifted. Our early moves into these additional markets, supported by our world-class investment research and acquisition teams, have led to our platform being much more diversified today than it was 15 to 20 years ago.
How important is the development of new assets to your platform?
Lowe: Development keeps our portfolio modern, allowing our team to provide input into the design and functionality of the building and incorporating modern specifications that will appeal to tenants. We are typically a longer-term holder of the real estate, and as such, we design buildings that will minimize obsolescence and future capital costs. More than half of the space in our platform today was developed rather than acquired. Development also has been instrumental in driving returns, taking advantage of the strong tenant demand for modern facilities.
Conklin: Having a development platform also allows for a wider and more creative approach to investing. Rather than just acquiring properties that others want to sell, we can pinpoint superior locations and build to best-in-class specifications. We have the flexibility to pursue acquisitions when it makes sense, but oftentimes, we see greater value in our build-to-core process. As the platform has grown, we have identified new opportunities to provide expansion space for our existing tenants as they grow their own businesses. We have also identified innovative opportunities, such as covered land plays of other asset classes — regional malls and office buildings — in very infill locations.
Each of you has been with Clarion 15 years or longer, with David, John and Andy having been involved with the platform since its very beginning. How do you explain the longevity?
Confer: Clarion’s partnership culture, leadership, and broader approach to innovative and disciplined property investment have proven an excellent match for our team. For more than two decades, we’ve been included as a vital part of the Firm and have been provided the resources and support we’ve needed to grow and strengthen our platform.
Lowe: Clarion Partners has long been supportive of the industrial sector, enabling us to build a great culture with a real passion for the industrial business. We’ve grown the platform to one of the largest in industrial real estate in the United States and the team takes a lot of pride in being a part of that success.
Killian: We leveraged experience and relationships as an early entrant to the market into a platform that has invested across several market cycles and has seen and participated in the changes to our industry over the past 20 years. And as much as we senior folks all love being a part of that journey, we know our future success relies on our ability to attract and train our next generation of leaders. Our Firm’s entrepreneurial spirit and hands-on culture empowers team members at every level to make an impact. We continually work to identify and hire the brightest talent and are immensely proud of the team we’re building for our Firm and investors.