Predicting real estate is a thorny business. This time last year, for example, who would have foreseen the events that have unfolded following the spread of COVID-19? Nevertheless, there are a number of aspects of industrial real estate upon which we can make some educated guesses.
It’s certainly not breaking news that online shopping is having an impact on the industrial sector. By all accounts, however, e-commerce leapt ahead in 2020, pushing the trend out to where it would have been in five years’ time. Is this a momentary bump or a permanent elevation?
“From everything that we’ve experienced and that I’ve seen, this is a game changer. And it’s going to continue,” said Bob Smietana, CEO of HSA Commercial Real Estate. “I think people’s habits, and their demands in terms of distribution and receipt of goods, has changed forever.”
The pandemic has accelerated the direct-to-consumer phenomenon by reaching out to late adopters. Whereas many consumers had already turned to online shopping out of expediency, many more did so this year out of necessity. Those in the latter group now understand the mindset of the former.
“There is a convenience factor,” said Adam Roth, executive vice president – industrial services, NAI Hiffman. “As an example, my parents now have bought a couple things online which is, relatively speaking, a minor miracle.”
We all remember the Great Toilet Paper Shortage of spring 2020. That represents just one of numerous examples where the global supply chain was proven to be operating too close to margins. The disruption created by COVID-19 created chaos in the system that traveled from manufacturer to distributor to retail to consumer.
“Frankly, the distribution network got caught with their pants down,” Smietana said. “Globally, the amount of stuff coming from just one country, China, was somewhere around 30 to 40 percent.”
As a result of this experience, many companies have signaled an intent to draw down their overseas presences. This may result in a reshoring of jobs to the U.S. or nearshoring to Mexico. Roth thinks most firms will go with an “Asia-plus-one” model; companies will maintain an overseas manufacturing presence, but due to supply chain risks and the ability to respond quicker to the market, some manufacturing will come back to North America.
The “just in time” process of aligning manufacturing volume with perceived demand has proven to be a flawed system. Regardless of where a widget is made, more companies now understand that it’s better to have an overstock to meet a potential surge than to miss out on sales due to lack of inventory. As consumers now expect next-day delivery on most items, this means more distribution facilities close to population centers. In fact, CBRE projections posit that every $1 billion in new sales among e-commerce companies will culminate in an additional 1.25 million square feet of demand for warehouse space nationwide.
From a distribution perspective, Chicago is positioned extremely well for the disruptions that have come about because of the pandemic. But according to Roth, two regulatory changes could have an equal, if not bigger, impact on the industrial real estate sector.
The electronic logging device (ELD) rule, a federal mandate that passed in 2017, was designed to improve safety on the highways by requiring truck drivers to electronically record their hours on the road rather than keep physical handwritten logs. A two-year grace period closed last December and as a result, the truck driver pool has been reduced.
As of this January, the Federal Motor Carrier Safety Administration also maintains a drug and alcohol clearinghouse, tracking truck drivers’ failed drug tests if and when they move to a new carrier. As a result, there are currently about 35,000 truck drivers that are “suspended” due to drug and alcohol clearinghouse.
“I’ve been going to the same trade shows and dealing with my same contacts for over 25 years now, and I have found that whatever they’re complaining about in transportation—and particularly in trucking and rail—trickles down to the real estate departments about a year and a half later. I actually call it the ‘rule of 1.5.’”
If Roth’s rule of 1.5 holds true, then reduced truck driver capacity will really start to be felt in the industrial real estate world next summer. Fewer drivers mean higher shipping costs, so distributors will likely focus on transportation-adjacent assets even more than they have in the past.
Secondary and tertiary markets may see more forward point deployment centers. Major transportation hubs like Chicago, however, are going to see an exponential growth in big box multistate distribution centers as firms look to offset higher trucking costs.
Investor and tenant activity
Chicago is positioned extremely well for industrial growth as there is a deep pool of buyers and almost unlimited capital that wants to get into the industrial space. This seller’s market is causing escalation in pricing and a near frenzy over any investment opportunities that come to market.
“That, coupled with aggressive debt, is putting downward pressure on cap rates,” said Roth. “I don’t see any decrease in the amount of capital looking to get into the industrial sector.”
According to Smietana, the submarkets that were performing well going into 2020 should continue to do so in 2021, for the most part. The space-constrained O’Hare and Northern Lake County submarkets have both seen good absorption in 2020 and the same should continue next year. Though HSA was able to lease up a 750,000-square-foot development in Shorewood, Illinois to a full-building user, Smietana points to the I-80 corridor’s glut of spec inventory as a reason that this submarket may see slower absorption levels.
Overall, however, construction of spec warehouses should continue apace. HSA is currently building a three-structure, 1-million-square-foot project in Bristol, Wisconsin. The firm’s decision to continue development during the early onset of the pandemic when others pulled back has paid off as approximately 5 million square feet of nearby competing projects were delayed.
Roth noted a peculiar and unprecedented theme that developed in 2020, as there was relatively consistent demand for 30,000-square-foot spaces and under, as well as, conversely, 500,000-square-feet and above. He speculated that some smaller companies manufacturing COVID-related products like PPE are taking the smaller spaces while interstate distributors continue to gobble up the big box warehouses. Other firms that would typically occupy those mid-tier spaces may have taken a wait-and-see approach during the pandemic.
There will be other disruptions for this sector in the years to come, including wider use of robotics, autonomous shipping, additive manufacturing and more that we have yet to dream up. But for 2021 and the near term, e-commerce, supply chain and transportation trends will continue to drive industrial real estate decisions.