One of Pelion’s key features is the ability for users to map and compare different real estate portfolios of REITs and real estate funds. This enables firms to analyze their properties in relation to their competitors and better understand the competitive landscape. Using this feature, we can better understand the concept of clustering.
What is Clustering?
Clustering refers to the practice of buying real estate in close or strategic proximity to one another. The motivations behind this are often to increase market share, influence rental/lease rates, establish a foothold in new markets, raise the barrier to entry, and reduce property management costs.
Clustering is used not only by real estate owners such as REITs and private equity funds, but also by businesses with significant brick-and-mortar components such as logistic companies, franchisors, and retailers. Firms that employ clustering to their advantage stand to gain financially and strategically.
Influencing Rental/Lease Rates
One of the key benefits of clustering is the ability to influence rental/lease rates and sale prices. Since lease rates and sales are benchmarked from nearby comparable properties, a landlord who controls the majority of space in an area is likely to be the benchmark.
A good example of this can be seen from Rexford Industrial, the biggest real estate owner of industrial properties in Southern California with 228 properties spanning 32.5 million square feet, according to Pelion’s database. Rexford’s footprint makes up 28% of the space owned by the top 26 institutional investors in the area.
As seen below, Rexford (light blue) has a presence in every major industrial pocket of Southern California. This dominance confers significant pricing power, which is evident in the REIT’s third-quarter earnings call when its co-CEO Michael Frankel reported that he expects the company to be able to increase rent by 27% over the next 18-24 months, “we currently project approximately $94 million, equal to about 27% of embedded NOI growth from our in-place portfolio over the next 18-24 months, assuming no further acquisitions.”
Frankel further touched on Rexford’s pricing power by saying “we also continue to see substantial price elasticity in terms of our tenants’ ability to pay increasing rent, particularly as rent typically represents a very small share of our customers’ economics.” The co-CEO goes on to say, “we are at a point where the drum is so tight and the more sophisticated ownership like Rexford in the market can now sort of drive pricing.”
Gaining and Defending Market Position
Another crucial application of clustering is in securing a foothold in new markets. An example of this can be seen from Kimco’s acquisition of Weingarten Realty in August.
Looking at the map of Houston with Kimco’s (green) and Weingarten’s (orange) properties together, we see that Houston was not a key market for Kimco, given its limited presence and the fact that its properties are located further out of the city core. On the other hand, Weingarten owned most properties in the inner ring of the city compared to other REITs. An acquisition of Weingarten would not only help Kimco strengthen its position but also make it the top player.
Despite Los Angeles being one of the prime markets that one would expect the two industry leaders to grapple for market share, we find that only Lineage seems to be the dominant player in the market, given the number of facilities that it owns just outside the city core. By clustering the properties strategically, Lineage has not only pre-empted Americold’s entry but also taken up the space and capacity needed to service America’s second-largest city. Consequently, Americold is forced to position its facilities further out of the city, likely to compete for smaller sub-markets, as shown below.
Differentiating Through Superior Real Estate
In today’s competitive environment, tenants are not merely looking at a landlord simply as a lessor but as a strategic partner. Tenants are also evaluating a landlord not just on a single property but a network of properties. This practice is prevalent in industries such as retail and logistics, where site selection is at the heart of a tenant’s competitive advantage.
Consequently, a landlord with strategically positioned assets, be it storefronts or distribution centers, that can help a lessee streamline his supply chain or maximize sales is likely to attract high-quality, long-term business. This is one reason why firms like Rexford cluster their assets together so as to help tenants minimize transportation costs and streamline operations. Therefore, it is imperative that landlords pay close attention to how their portfolio is positioned relative to peers so as make themselves the most desirable real estate partner.
While simple in theory, clustering can offer property owners significant financial and strategic advantages. Firms can not only gain pricing power and strengthen their foothold but also differentiate themselves through having a superior real estate portfolio. The increasingly competitive nature of the real estate industry is forcing landlords to raise their value proposition, and clustering is one of the strategies that operators can utilize to compete effectively.