Land CRE: 30 Years Later

When you think of the land sector of CRE, you might not think there has been many changes. After all, it doesn’t change much on its own. Well there are many facets to this sector, and just as the world has changed a lot over the years, so has this sector and how we use it. With everything rapidly evolving with this global pandemic, it’s important to understand all of these modifications and how they are being addressed.

In 1990, there was barely a mention of tertiary markets by large, national commercial real estate developers. Primary markets such as New York, Boston, Atlanta, Dallas, Houston, Chicago and Los Angeles were everybody’s targets, while some secondary markets like Indianapolis, Seattle, Denver, Kansas City, peeked through. Dense population is a major factor, with 70% of the U.S. Gross Domestic Product resulting from consumer spending. This mostly impacts retail, but population drives all asset classes, and institutional investors—many still new at investing in real estate—feel more comfortable with major metro areas.

Tertiary markets were partially based on size of the trading area, partially on sheer population and prospects for growth, and all impacted by the health of the local economy.

As for land needs in industrial, in the ‘80s and early ‘90s it was important to be near existing power and water for manufacturing, and of course, ideally close to where the population was, as labor was an increasing factor and non-union was preferred.

Thirty years later, however, land needs for industrial began increasing for large distribution centers that could service a good part of North America’s population

The bigger the market, we also see three things: the greater the demand for land at major intersections for fast food growth (heaven help you if you’re not on the right side of the street during commute times); the more prevalent mega warehouse purchases become, the more likely it is for a developer to tear down an older facility to build new (where land prices are so high, demo work can make sense); and, from a regulatory, infrastructure, and cost perspective, the harder it is to do inner-city development. Then if you’re in a place such as Indianapolis or Columbus—where land is flat and stable—you’re in much better shape than in Los Angeles (where regulations add a good year to a pro forma), Louisville or Nashville (where soils, flood plain, or nasty topography get in the way, or Boston (where 500 years of history can turn up in an excavation; the Big Dig—estimated in 1982 to cost $2.8 billion and take seven years—ended up costing over $8 billion and took 15 years).

So land, at best is an iffy proposition. It takes months to properly evaluate and incorporate into a business model that is economically viable.

Big changes in 30 years in land acquisition include: properly handling Native American burial sites when uncovered; properly designing storm water and water runoff characteristics, with proper retention, so as not to unduly impact neighboring properties; proper harvesting of woodlands without disturbing mating patterns of endangered avian or other species; and in many more rural areas, properly relocating family cemeteries, some of which can contain dozens of graves.

But technology has helped. In 1990, a project known as a “cut and fill” site with rolling topography could often end up with either a need for hundreds of truckloads of fill dirt or a need to dispose of any extra dirt. Today, within minutes, a topo can be created and a design suggested, all with a computer-generated accurate estimate and without importing or getting rid of dirt. Moreover, with laser and GPS technology, earth moving machines can be programmed to carve up the site exactly to design without much operator input.

But land is land. As the saying goes, “they ain’t making any more of it.” So as metro areas develop, the tradeoffs are: pay more, take more risk away from the owner/farmer (i.e. pay dearly for an option to buy), compromise on what’s the best location, or buy an older facility and raze it properly.

It’s difficult to assess trends in land values, but in a strong economy, common sense says that the supply will dwindle, and the demand won’t stop—so up go the prices. In certain sections of the country, they have skyrocketed. Scarcity and these increased land prices have given rise to some multi-story warehouses in the U.S. for the first time since the 1950s (major difference: those were all freight elevator-dependent; these new versions have truck loading and unloading on every level), after seeing the success in other countries such as Japan and Singapore. Multi-level warehouses require much less land, but do come with exorbitant prices, with much more expensive construction to accommodate truck traffic on upper levels.

What will eventually hold land prices in check will be a mild hike in inflation, which pre-COVID was hovering around 2% or lower with 10-year T-bills yielding below 1.8%. Today it’s lower with inflation nowhere to be seen. When both rise, today’s historically low investment CAP rates will as well, putting downward pressure on real estate value, and squeezing profit out of new development. Land will be the first place cuts will be made in new development.

Land values, depending on intended use, are either severely impacted, moderately impacted, or not impacted at all by COVID-19. Without any discussion of re-zoning, the current—and perhaps long-term—impact on land is as follows, and summarizes much of my recent sector posts:

Hotel development: As explained in the hospitality post, post-COVID, it’s extremely unlikely that any new developments will take place soon, so the land value has plummeted.
Office development: Due to the remote, video-connected new office paradigm, office vacancies are extremely high. Even those offices that have re-opened have strict guidelines on density, far less than what was normal last year. COVID and the already-in-place trend to work outside of traditional office settings has made it impractical to build or even plan office construction. Land devoted to this use should be far less valuable until, and if, this ever changes.
Retail development: This one’s a little trickier. Drive-through restaurant locations will be in high demand. Gas stations should be relatively unaffected. As for pharmacies, there was already a trend in going online, so it remains to be seen whether there will be active development of new brick-and-mortar drug stores such as your corner Walgreens.
Regional and Lifestyle Center malls: The trend to online purchases, which was increasing annually by 1-2%, has accelerated to 5-7%, and is expected to continue to grow at the expense of traditional brick-and-mortar.
Medical: This one’s a wild card. Hospitals have been hit hard by the virus as elective surgery, for example—the most profitable line item—was shut down. It remains to be seen how the industry will stabilize. Medical offices have been so unpredictable for years that it’s difficult to project with any accuracy what the future holds. It’s likely that landowners will, of necessity, stay patient.
Industrial: In the Midwest, industrial is as strong as ever and likely to get better. Some estimate that e-commerce acceleration from COVID will mean 250 million square feet of new e-commerce construction. And the need is not just for e-commerce distribution centers, as there is also the likelihood of significant manufacturing re-shoring in the next few years. In addition, just-in-time delivery—almost a necessity in today’s consumer driven world (about 70% of the US GDP is consumer spending)—requires much more land to be acquired per project to accommodate parked trailers. Also, warehouses built over 20 years ago with limited or no trailer parking, will desperately seek nearby land for trailer parking. Those who would own such land and choose to lease it can achieve monthly rentals of $200/trailer/month in the Midwest (higher in gateway cities) so such land is spiking in value.
Self-storage: Inside Self Storage, a longtime media organ for the industry, predicts offsetting phenomena will keep the industry steady and future developments viable. The downward pressure, they say, will come from increases in delinquent accounts from furloughed and laid-off employees if it continues throughout the year. In their opinion, though, there will be an increase in business because “The silver lining is [that] our industry will see a temporary push in demand from customers who’ve been forced to work from home and need more space, college students who need to store possessions after vacating campuses, and others who’ve been displaced due to layoffs.”