Mariwyn Evans writes about commercial real estate for REALTOR® Magazine. You can reach her at email@example.com.
Warehouse Demand: Strong Signs of Life
Even as vacancies drop, higher energy costs and shifting logistics models may be changing the dynamics of industrial storage.
July 1, 2011
One reason investors like warehouses is that the demand principles are simple. If a company makes something or imports something, it has to put that something somewhere until it reaches the end user. That equals demand.
International trade accounts for approximately 35 percent of industrial space demand, says Rene Circ, national director of industrial research for Grubb & Ellis. So it’s not surprising that with a 14.3 percent jump in imports during 2010, according to Mario Moreno, economist with The Journal of Commerce, the overall national industrial vacancy rate fell to 10.2 percent at the end of first quarter of this year, down from 10.3 percent at the end of 2010, according to Cushman & Wakefield. This rate compares favorably to the 10.8 percent of the industrial property vacancy in the first quarter of 2010.
How to Foresee Industrial Demand
If you want to get a quick indicator of what industrial demand will look like at this time next year, the place to look is the Purchasing Managers Index, published monthly by the Institute of Supply Chain Management, says Randy Anderson, professor of real estate at the University of Central Florida in Orlando.
Anderson, along with Harry Guirguis of Manhattan College in Riverdale, N.Y., analyzed the impact of more than 40 economic and real estate indicators, including that index, to develop the new NAIOP Industrial Demand Index.
Anderson pays particular attention to the Purchasing Managers Index because, unlike indicators such as gross domestic product, industrial employment, and rail and cargo transportation, which move at the same time as warehouse demand, the index "is a good way to monitor and forecast demand." Why? "These people have their boots on the ground and know when something is going to happen," he says. The other top indicator, the Index of Manufacturing Output published by the Federal Reserve, shows when manufacturing really occurs. An uptick here will indicate increased industrial demand in about two more quarters, says Anderson.
Anderson and Guirguis expect to see an annualized rate of growth of 1.5 percent in industrial demand for the second quarter of 2011, an increase from the 1.1 percent annualized growth in the first quarter. Ultimately, Anderson says, predicting demand is less about an exact number than "stepping back to see changes in the direction of demand and the risks those change points represent."
The picture looks even better for the rest of 2011. Moreno predicts that imports will grow by an estimated 6.5 percent and exports by 8.8 percent for the year. That means more business for ports, especially the 1 billion square foot Los Angeles-Long Beach market, which handles about half of all imports from Asia. Industrial vacancies in the South Bay market are already dipping near 5 percent, says Jesse A. Laikin, SIOR, senior vice president of Lee & Associates in Gardena, Calif. And even with robust demand, "many landlords would rather renew a good tenant than get a rent increase," Laikin says. East Coast ports, which account for the highest share of U.S. exports, are also seeing rebounds. "Every 1 percent of incremental growth in foreign economies translates into a 3 percent jump in the purchase of U.S. exported goods," says Michael Alderman, senior vice president of industrial services with Jones Lang LaSalle Americas Inc., in Mechanicsburg, Penn. Supply is already exceeding demand for space for small and mid-sized warehouses near the port, reports Ian Grusd, CCIM, SIOR, managing director at Sperry Van Ness/Richter Grusd in Iselin, N.J. The opening of the Panama Canal expansion in 2014 will only add volume in ports from Jacksonville, Fla., to New Jersey.
Growing economies in Brazil and Columbia are also fueling deals and even pushing up rents in some Florida submarkets, says Steven Medwin, CCIM, SIOR, managing director of Jones Lang LaSalle Brokerage Inc., in Miami. "In the last year, about 75 percent of our transactions have been companies taking more space," he says. "Companies that survived the recession are gaining market share from weaker competitors and growing."
At the same time, not all port cities with growing trade activity are seeing higher warehouse demand. Circ points to Prince Rupert, B.C., as the extreme example of this disconnect. The Canadian port handled 343,000 twenty-foot equivalent units (intermodal containers) in 2010, nearly all of which went directly to Chicago and other Midwest destinations by rail.
A Time to Lease, a Time to Buy
Even in improving markets, demand hasn’t often translated into rent increases. This presents an opportunity for more confident companies to try to lock in longer leases before rents tick up. "We’re seeing requests for five-, seven-, and 10-year terms," says Medwin. Landlords aren’t always eager to go along, since they too hope for improvement, he adds. Yet, even in better times, smart tenants are doing "a reverse credit check" to be sure landlords can pay for improvements and maintenance expenses, says Paul Waters, cre, SIOR, executive managing director, The Americas, for NAI Global. "Whether a landlord is financially sound is the second question tenants ask after rental rates," he says.
Not all tenants are optimistic. "Many companies are still pushing for two- and three-year leases and taking smaller amounts of space with a right of first refusal to take more square footage," says John Neely, SIOR, principal with Colliers International in Savannah, Ga. Still, he adds, inquires have picked up, and "it’s beginning to get a little more like normal."
The possible impact of new lease accounting rules, which require operating leases to be capitalized on the balance sheet, may also favor shorter leases if and when they’re finalized by the Financial Accounting Standards Board. The proposed rules "are definitely on the radar of larger companies," although they haven’t yet affected many leasing deals, says Scott Marshall, senior managing director of CB Richard Ellis in Oak Brook, Ill.
Tightening supply and low interest rates have also spurred buyer interest in many markets. Like other commercial property sectors, sales divide into either mega portfolio deals done by REITs or institutions and smaller purchases most often made by owner-occupiers with SBA loans or local bank financing. On the institutional side, "we’ve seen package deals of class A properties trading at approximately 90 percent of 2007 highs," notes Marshall.
Regional investors are taking advantage of troubled loans and foreclosures if they can find the capital, but "there are so few transactions, it’s not a trend," says Neely. Grusd is seeing an "extremely active" investor market for spaces under 100,000 square feet. Demand is so strong that his company has begun calling owners of vacant and troubled properties to match them with current clients, he says.
A More Dispersed Supply Chain
Perhaps the biggest unknown in the industrial market recovery is what rising energy prices will do to demand. The most obvious threat is that higher costs will sap consumer spending and reduce imports. But energy costs could also encourage more retailers to shift their distribution strategies away from a few mega-warehouses to more dispersed distribution centers closer to individual retailers.
"There isn’t much concrete to point to yet, but logic says that as energy costs increase, distributors will want to be closer to major consumer markets," says Dieter. A possible federal regulation that would reduce truck driver work time from 11 hours to 10 hours would also favor more scattered distribution, says Marshall.
More warehouses may seem counterintuitive in an era of tight cost controls and high vacancies, but real estate costs usually represent less than 5 percent of the total cost of moving goods, while transportation represents over 50 percent, says Chris Teesdale, SIOR, executive vice president of Colliers International Dallas-Fort Worth. That’s why two strategically placed warehouses instead of one can have a positive effect on the bottom line. Still, he says, the decision on where to place distribution is "a balancing act" that requires industrial brokers to understand a client’s operations and needs.
Just how high do fuel prices need to be to justify dispersion? Alderman recently conducted a study for a national book chain that distributes products from three warehouses. "At $150 a barrel, they would find it more profitable to shift to five distribution centers; at $200 a barrel, the number grows to seven centers," he says. Higher energy costs will also favor rail transport and more aggregation to avoid partial shipments.
In some instances, dispersion is already happening. "We recently sold a 95,000 square foot warehouse in Bayonne, N.J., to a company that distributes candy and popcorn to movie theater and entertainment venues," relates Grusd. The company had decided to shift from one warehouse servicing the entire Eastern seaboard to one exclusively dedicated to the Tri-State area and another in the Mid-Atlantic area. The trend toward more warehouses may favor smaller, yet strategic, markets like Louisville, Ky., and Memphis, Tenn., says Dieter.
More dispersed distribution models could also help increase the total demand for space, not just where it’s located, says Circ. "For every 10 percent increase in the number of distribution nodes a retailer has, it will have to increase inventories by 5 percent," he says.
Signs of life in warehousing are good not only for industrial brokers but also for the entire commercial real estate industry. "Industrial will lead us out of the doldrums; it always does," Waters says.