The 5 US cities for industrial investments that are most likely to outperform benchmarks

Which cities are most likely to beat the benchmark for industrial returns?

It’s no secret that the commercial real estate (CRE) industry has experienced heightened volatility over the last few years; the post-pandemic CRE landscape is undeniably different than the one that existed prior to 2019. The office sector, in particular, has borne the brunt of the post-pandemic impact, as a mass exodus from in-office work materialized, and has since ushered in a new ‘norm’ of hybrid work. On the residential side, densely populated city centers continue to grapple with housing affordability and development challenges, as high borrowing costs are further exacerbated by development delays, labor shortages, and high construction costs. Retail, for its part, has demonstrated resiliency in the face of economic headwinds, as retailers find ways to adapt and recalibrate their offerings to better align with consumer preferences in the current landscape.

The industrial sector, on the other hand, found itself in a unique position throughout the pandemic. While the rest of the world came to a relative standstill, the consumer demand for e-commerce goods and last-mile delivery peaked. As of 2022, the industrial and logistics sector appeared to be experiencing record growth that stood in contrast to the downturn faced by other sectors. Today, demand across the industrial sector has slowed in response to new supply, the normalization of tenant demand, and some looming economic uncertainty. Even still, the industrial sector bears a healthy outlook, with demand for existing buildings remaining high and moving towards regions with high manufacturing outputs and favorable locations within supply chains.

In this environment, it becomes imperative for investors to take a deeper dive into sector and city combinations. This is not a market where everyone wins; however, those who do their due diligence to strike the right balance between risk and reward are likely to find success while building a healthy, diversified portfolio.

To identify the top 5 US cities for industrial investments that are more likely to outperform the benchmark than other cities, Sally Johnstone, Sr. Manager, Market Insights Delivery at Altus Group, leveraged the Capital Asset Pricing Model (CAPM) via the Altus Market Insights. Last month, we performed this analysis to determine which US cities are expected to provide multifamily returns that outperform the benchmark.

The CAPM model provides an alpha and beta score that predicts the future performance of CRE sectors in different markets compared to NCREIF NPI benchmark returns. To understand the scores provided in Johnstone’s analysis, which was completed in Q1 2024, it’s important to know the following:

• The alpha score measures how well an investment performs compared to the benchmark, based on its risk

• A city/sector combination with an alpha score of zero and a beta score of 1 is expected to perform in tandem with benchmark returns

• A positive alpha score indicates a city/sector combination that is expected to outperform benchmark returns

• A beta score greater than 1 carries greater risk, but also a greater potential reward

• Higher betas outpace the benchmark when the benchmark is increasing (but also bring more downside risk, as they decline faster than the benchmark)

In simple terms, CAPM helps an investor understand the relationship between the expected return on an investment (the reward) and the risk associated with it.

A more detailed breakdown of the CAPM approach is provided at the bottom of this article.

What factors impact industrial performance?

There has been considerably more variability quarter over quarter in the alpha score for industrial cities compared to the multifamily alpha scores, which is to be expected. While multifamily demand remains fairly stable across select regions, the industrial sector has faced a number of supply chain disruptions and changes in consumer behavior. Although e-commerce demand peaked during the pandemic, consumer preferences now appear to be split between the need for convenience and the desire for in-person, boutique shopping experiences. With these factors in mind, some variability in total returns is to be expected across the industrial sector.

“It’s interesting to note that none of the Southern California ports are represented in our top five,” notes Johnstone. “It doesn’t mean that those locations are underperforming; rather, their returns growth is simply not expected to outpace the benchmark. When we take a closer look at the trends that may be impacting expected returns in these regions, we see that new industrial supply came online right around the time pandemic demand began to ease, and some ports and regions were more impacted than others. For example, a port like Miami, with its land constraints, has been able to maintain rent levels better than other areas where supply is more easily generated.”

Miami-Miami Beach-Kendall, FL

Miami has been consistently in the top 5 markets for industrial alpha as long as we have been tracking this score. In fact, the growth in industrial alpha levels in Miami is a phenomenon we discussed in-depth last year, when Miami jumped to the top as a leader in third-quarter and year-to-date performance. According to an Altus Group analysis of NCREIF ODCE Index returns at that time, Miami industrial assets had posted a total year-to-date return of 6.7% through the third quarter, compared to the national average total return of -5.1% for the same period. Our most recent alpha score for Miami indicates that its performance has continued through the beginning of 2024.

“There are a handful of factors that help to position Miami as a good bet for benchmark-beating returns across the industrial sector,” explains Johnstone. “The Miami MSA has had one of the fastest-growing economies in the US, and while the supply chain disruptions across West Coast ports that drove increased shipping volume into Miami have somewhat mitigated, the area still has land constraints and a growing demand for warehouse space that should continue to support higher-than-average returns.” According to an Altus Group analysis of NCREIF ODCE Index returns at that time, Miami industrial assets had posted a total year-to-date return of 6.7% through the third quarter, compared to the national average total return of -5.1% for the same period. Our most recent alpha score for Miami indicates that its performance has continued through the beginning of 2024.

To Johnstone’s point, Miami’s Gross Area Product (GAP) growth from 2021 to 2024 was in the top 10 in the nation, with 1.5x more US Gross Domestic Product (GDP) growth in the same period. Moreover, average market rents for Miami industrial warehouses grew about 25% from 2021 to 2024.

Cambridge-Newton-Framingham, MA

Cambridge-Newton-Framingham, MA has also been in the top 5 industrial alpha cities since we began tracking this data. Much like Miami, the Cambridge-Newton-Framingham MSA had favorable economic growth, in addition to strong demographic drivers in the area. To this effect, its GAP growth from 2021 to 2024 was in the top 10 in the nation and beat US GDP growth for the same period by about 1.5x. Cambridge has also seen about 25% growth in average market rents from 2021 to 2024, and it’s important to note that the entire Boston area serves as New England’s regional distribution center.

“The area has a per capita GAP that is double the US average, which reflects the strength of its science, technology, engineering, and mathematics sectors,” notes Johnstone. “Household income and wealth, which are significant drivers for last-mile warehouse demand, is also in the top 10% of US cities. After all, a region with more household wealth is presumably less impacted by economic volatility. The consumers that live in this area are likely more resilient to economic headwinds.”

Reno, NV

Notably, Reno, NV is the smallest city on the top 5 list, and while it’s not always in the top 5, it has been in the top 10 for industrial alpha for as long as we’ve tracked it.

“The market rents in Reno have grown more than 20% over the last three years,” Johnstone points out.
“But the demand for warehouse space in Reno has less to do with changes in macroeconomic and demographic factors in the immediate area than it does in other regions. Its GAP, labor force, household income, and other growth metrics are just slightly better than the US average. Instead, the strength of Reno’s industrial sector appears to be correlated with its convenient location.”

Located just inland from the Southern California ports, Reno sits within 250 miles of millions of households and offers its industrial tenants a low cost of doing business, as operating costs (such as utilities) tend to be lower in Reno than in most parts of California. The Reno airport also serves major air shippers, which helps to prop up the supply chain in that area.

Tampa-St. Petersburg-Clearwater, FL

Tampa-St. Petersburg-Clearwater, FL has been in the top 5 industrial alpha cities as long as we have been tracking this metric. Industrial rent growth has not been as strong in Tampa as in Miami and Cambridge-Newtown-Framingham (hovering around 13% over the past three years), but it is still higher than other cities and vacancies remain low, which should help the region maintain rates and rate growth.

“When I look at this region, the strength of its labor force is what grabs my attention,” adds Johnstone. “The labor force in Tampa has grown at twice the pace of the US on average over the past 3 years, and Tampa is also part of the I-4 corridor in Florida, which is a significant distribution area for most of Florida.”

Washington-Arlington-Alexandria, DC-VA-MD-WV

The DC metro area finds itself in the top 10% of cities for per capita GDP, household income, and household wealth – all of which are important factors for industrial performance. Moreover, industrial warehouse market rents have grown more than 15% over the past 3 years, and vacancy rates remain low.

“This area only recently moved into the top 5 industrial alpha score cities, so we’ll want to keep an eye on it to see if it continues to show indications of strong future returns, or if it is closer to the middle of the pack,” Johnstone explains. “The timing of leases may be a factor here – if a lease for a warehouse space was signed before the pandemic, its rate was likely significantly lower than leases that were signed in 2021. So, if an area sees an influx of newer leases, a temporary increase in returns may materialize.”

Conclusion

Data tells you where to focus your attention, but deciding to invest in any city/sector requires due diligence. Even if a region is expected to beat the benchmark for returns, there may already be a premium to pay for that city/sector. As an investor, you have to decide what makes sense for the long-term picture. Will the cost-benefit remain in your favor, not just right now, but over the long term?

“Although alpha beta measures typically hold over a 3-year time horizon, you also have to remember that exogenous shocks to the system – such as a pandemic or geopolitical event – can always occur, that may impact city/sector combinations in ways the data could never have predicted,” adds Johnstone. “Fortunately, shocks to the system are rarely a catalyst to immediate change; a market will not soften overnight, but major fluctuations can materialize over time as the market adjusts.”

It's also important to note that the top-performing industrial city/sector combinations in our analysis have beta scores less than one, which can somewhat constrain performance compared to the benchmark when returns are increasing. However, lower beta also means lower risk, so when the benchmark declines, a city/sector with a beta score less than one declines much less. “With the increase in industrial supply and moderation of demand for warehouse space, growth in returns has been constrained in most of the industrial city/sector combinations with higher betas,” notes Johnstone. “These five cities, however, have been less constrained and, therefore, present greater potential.”

Understanding CAPM

The Capital Asset Pricing Model (CAPM) is a financial model that calculates the expected rate of return for an asset or investment by using the expected return on both the market and a risk-free asset, and the asset’s correlation or sensitivity to the market (beta). In simple terms, CAPM helps you choose the best city and sector by balancing expected returns with the level of risk, guiding you toward investments that align with your risk tolerance and return goals.

Alpha and beta scores are based on the past 20 quarters of city/sector data for a given region. A positive alpha indicates returns that outperformed the benchmark, while a negative alpha indicates constrained returns compared to the benchmark. The beta score, on the other hand, reflects a city/sector combination’s relative sensitivity to the changes in benchmark returns. Please note that for our analysis, we use the NCREIF NPI as our benchmark.

For a deeper dive into this model and the validity of alpha as a predictor of future risk-adjusted returns, skip to minute 4:00 of our webinar: Using Data Science to Improve Your CRE Portfolio

Want to be notified of our new and relevant CRE content, articles and events?