Demand, Sustainability and Automation: A Q&A with Prologis

By Mia Goulart, Senior Staff Writer

Chicago continues to be a magnet for REITs, especially for those seeking industrial space. As for what makes the region a secure opportunity for investors, Prologis’ Sean Olvany, VP, Market Officer – Chicago, recently weighed in.

Chicago Industrial Properties: What are your current observations on the demand for logistics real estate in the Chicago market and how has this demand evolved over the past few years?

Olvany: The fever pitch seen during the pandemic has somewhat (and expectedly) normalized—but demand for logistics real estate in Chicago remains very strong. We use a number of metrics to gauge demand including the Prologis Industrial Business Indicator (IBI™). In March, the index fell to its lowest level in 2.5 years alongside overall economic uncertainty. Then, in April, the reading significantly increased to a normal expansionary market level.

Generally, the FOMO has decreased with less backup deals waiting in the wings. We are seeing less retailers and 3PLs lease space speculatively and lease negotiations times have extended.

CIP: How does the logistics industry contribute to Chicago's economy, and what are some of the key factors that influence demand for industrial space in the area?

Olvany: With one of the most diverse economies in the U.S., Chicago is often insulated from downturns in particular sectors. The size of our population, the business presence and the fact that we sit in the middle of the country all plays to our benefit. We’re also well served by a well-established manufacturing base and logistics network as well as North America’s second largest inland port and two hub airports.

CIP: Can you speak to any recent trends in building design for industrial properties, such as clear heights, sustainability features or the use of solar energy? How do these trends impact your investment strategy and leasing decisions?

Olvany: Our company is laser-focused on incorporating renewable energy and sustainability features in our properties in Chicago and across our global portfolio. We have dedicated teams creating energy efficient specifications for our construction projects. We are upgrading the steel in roof system to accommodate solar, upsize electrical service and gear for energy readiness, and ensuring that at least 50% of employee parking is EV ready.

Our customers are asking us for sustainable solutions, and we have an ambitious goal to reach net zero emissions by 2040. We are taking significant steps to reach it, including incorporating the reduction of cement and concrete in building design. We are also leveraging our physical scale and installing solar on our rooftops where and when it makes sense. In fact, Prologis is ranked No. 2 in the U.S. for onsite solar capacity.

CIP: How do you address challenges related to labor shortages and material delays when developing or managing industrial properties, and what steps are you taking to mitigate these risks?

Olvany: The Chicago market has not been impacted by labor shortages as much as others, but we are not immune. We employ technology to improve efficiencies and free up our team to focus even more on our customers. For example, we partner with SITE Technologies, a tech-based property assessment, to help manage paving.

Further, our in-house procurement team leverages our scale and network to achieve the best value. We also are selective when hiring general contractors and vendors, partnering with companies that have the right staffing and expertise to support our customers and us.

CIP: How do you evaluate the potential impact of new technology on the industrial real estate market, and what role do you see for automation and robotics in the logistics industry?

Olvany: Automation will continue to become more prevalent in logistics. More of our customers are leveraging automation and robotics in our facilities, particularly robotic material handling equipment. We recently hosted an event in our incubator space in Woodridge, Illinois, with Gideon Robotics to demo their autonomous forklifts with our customers and brokers.

Everyone’s talking about AI, and we believe will be a major factor in our industry in the years ahead. We already use it in forecasting and revenue management. We have only scratched the surface and anticipate this will be the next big disruptor in commercial real estate. It is now predicted automation will exist across a quarter of all warehouses by 2027.

Sustainable logistics solutions are also in high demand. Our corporate venture fund, Prologis Ventures, focuses on investments across renewable energy, sustainable construction materials, and the creation of our Mobility business. Electric trucks are coming, starting with electrifying heavy duty drayage operations. Recently, in the Chicago market, our Mobility team installed an electric fleet depot charging. The operation will have 100 Class 8 trucks with over one million annual miles electrified, resulting in 5.7 metric tons of CO2 saved annually.

CIP: Can you talk about the geographic distribution of your real estate assets and how you prioritize different regions or markets for investment?

Olvany: In Chicago, we focus on core/ infill submarkets where we have the largest customer base and are near the highest barriers to entry—particularly O’Hare, I-55 Corridor and Central DuPage County.

The past five years, we’ve been growing our “Last Touch” portfolio—18 global urban markets with the highest income density, such as New York, Paris, Mexico City and San Francisco. In Chicago, our “Last Touch” portfolio totals more than two million square feet. Of the 12 prop- erties, 11 of which have been acquired since December 2018.

CIP: What is your outlook for the rest of 2023, and how do you anticipate that the demand for logistics space will evolve? How will Prologis adapt to changes in the market, and what opportunities do you see on the horizon?

Olvany: We feel great about the rest of 2023 and beyond in Chicago. We be- lieve we’ll see some cooling of demand, which may bump up vacancy a bit, but that should level out in early 2024 due to the current drop in speculative construction starts. quences, is driving up rents and making it harder for tenants to find affordable options.

One metric we track is “true months of supply” (TMS), which compares all vacant spaces (existing + unleased development pipeline) to trailing net absorption. For Chicago, TMS increased in Q1 to 31 months (up five months from Q4). Even as TMS rises from trough levels, it remains very low and consistent with positive real rent growth (<50 months = rent growth). Chicago is not at risk of this rising suddenly given the limited unleased development in the pipeline and shrinking construction starts.

Rents are still rising, and we project they will continue to rise even with an increase in vacancy. We still expect double-digit rent growth this year in our core/infill submarkets.

On the acquisition side, we don’t foresee as many distressed opportunities as anticipated, but will continue to see more sale-leasebacks, covered land plays, and office campus redevelopments, which are the types of deals we are targeting.

This is the case across the board, but it’s especially tight in infill markets like O’Hare, I-55, Central DuPage, I-88 West and Lake County, to name a few.

In fact, across Chicagoland, 96% of all Class B and Class C buildings are currently occupied, forcing potential tenants to consider more alternatives, like paying more for Class A or expanding their geographic parameters outside of the region to better accommodate their search.

Additionally, NAI Hiffman Executive Vice President Joe Bronson said there are very few Class C options that are functional, only limiting the options further.

“When I give clients a report of spaces available, they often ask why I sent them a report of only “new” buildings,” Bronson said. “The tendency to renew leases is even stronger than usual because of this.”

Even in terms of new development, companies like NAI Hiffman and Core Industrial Realty have seen shifts in patterns of that of spec. Bronson said current interest for spec development lies with a much smaller group of buyers—and sells at a lower cost.

“We as a market have to decide if the exurbs are going to finally become just the next ring of suburbs,” Bronson said. “And if the answer is yes, will there be enough labor to support the tenants in those buildings?”

That’s just another rung on this year’s ladder of unknows and how things will play out, but it’s not necessarily a “new” issue.

Core Industrial Realty Managing Broker/Founder Noel Liston agreed it’s true that there is limited availability in lower-tier asset classes, for purchase in particular, and business owners that prefer to own versus lease are having a difficult time finding product to buy.

That said, Liston said we might start to see supply grow a bit in these asset classes in the latter half of the year, and like Joe Bronson said, geography is also something to be considered.

“In the secondary markets, we started to see some product emerge for sale, which is typically an indication that you’ll start to see other product for sale in more established submarkets,” Liston said. “We currently see some vacancy in the periphery markets, and I predict a bit more will be added to the market later this year, creating more opportunity for those that have not been able to find a building to purchase.”

The outlook for the near future revolves around the positioning of capital costs, as there remains a significant level of inactivity while people await the stabilization of rates. Investors hope for a scenario where there are no rate increases in the second half of the year and a downward adjustment to the Fed funds rate beginning in early 2024, however, whether this becomes a reality, along with many other uncertainties of the year, remains a “wait and see” situation. The encouraging news is that supply and demand are relatively well-balanced at the moment, and the limited availability of land and fewer land purchases will result in a lower inventory of new product next year, sustaining the equilibrium between supply and demand.

“It remains a landlord’s market, but there might be equilibrium toward the end of the year where the market neither favors tenant nor landlord,” Liston said. “As for vacancy rates in the second half of this year, I don’t anticipate much change, but I remain bullish on the near future of the market overall.”