The industrial sector is being reshaped by a couple of significant trends rippling across the landscape today, at least that is the vantage point of SIOR Investment Member Group Steering Committee vice chair Steve Kozarits, SIOR, an industrial leader who handles tenant representation assignments for corporate occupiers across the U.S. First among the drivers is the fact that industrial vacancies across the board are at an all-time low. Rents, although experiencing a period of stabilization, remain as high as they've ever been in Kozarits’ 40 years in the industry.
Labor, Technology, Onshoring & Reshoring
“In the past, we searched for buildings. Now we look for labor markets. It's a combination of obviously the bricks and mortar are critical, but if an industrial tenant can't find labor to work in these facilities, that's a problem,” he said. That is one reason there’s been a push and great strides taken to build automated warehouses and incorporate robotics. That solves a couple of problems in the industrial space. One, it can reduce the dependency upon employees to get tasks completed and overall, it also reduces the operating costs of the facility, whether it is a manufacturing or distribution site, points out Kozarits, who serves at Transwestern as a senior vice president in the firm’s Industrial Services, Tenant Advisory group in Chicago.
The onshoring and reshoring trend is another significant trend shaping the industrial sector that industry experts are tracking closely. “It is a real factor, especially for the clients we work with that are headquartered in Europe,” said Kozarits. “They are all seeking to mitigate the risk of revenue, since a large component of it is derived from North American sales. If they don’t currently have a plant in the U.S., they are working hard to establish a presence here.”
That increased focus on expanding domestic manufacturing in the U.S. clearly is having a tremendous and long-lasting influence on the U.S. commercial real estate market and the broader economy. Many predict that the U.S. is entering a manufacturing investment “super cycle” that will extend into the second half of the next decade. That is driving development of manufacturing space, which resulted in 19 million square feet of demand at the end of 2022. A significant number of businesses have brought, or plan to bring, all or part of their manufacturing operations stateside in the next three years. In turn, that is driving up spending on U.S. manufacturing construction, which has nearly doubled since the end of 2021. Manufacturing starts increased 211% from January 2019 to June 2023.
Another trend being experienced in North American markets is reshoring as a way to improve supply chain issues. It's a combination of risk mitigation, and supply chain improvement. “I don't see those trends going away in the near future,” said Kozarits. “Unfortunately, what's going on in Europe is driving a lot of this just because of the unpredictability of energy and the soaring cost of energy. European firms are looking to come to the U.S. to establish a presence here.”
In the first half of 2023, the Reshoring Initiative reported that average spending on U.S. factory construction was more than double the average from the past 17 years. Reshore Now also noted that jobs are returning to the U.S. in record numbers. For the first half of 2023, reshoring and foreign direct investment accounted for 182,000 announced jobs. The cumulative number of jobs brought back since the manufacturing low in 2010 is anticipated to be near two million by the end of the year, roughly 40% of what was lost to offshoring, reports Reshore Now. To put recent announcement rates into perspective, it took 11 years to return the first million jobs and only three years to return the second million, points out the organization.
Sustainable Industrial
The other interesting trend in the industrial sector is there has been an increase in rail usage. Sustainability within the industrial sector is becoming more important. For every railcar that gets used and filled, it is estimated that 3 to 4 trucks get taken off the highway and thus reduce a company’s carbon footprint, points out Kozarits. “For some companies, that's a goal they strive to meet each year. Many companies that are trying to reduce their carbon footprint and using rail as one way to accomplish that,” he said.
The unknown for the industry right now is the electric grid. “It's old and it's dated. And I think the if you're checking boxes, when you're doing a site search for a company you check the labor box and then the next box you check is power,” said Kozarits. Finding out early if power is available at the site or if a transformer is needed to be brought in is critical. It may take 12 to 18 months to install a transformer or build a substation, which will require that it be ordered as soon as ground is broken on a project.
Although companies are not yet building infrastructure for electric over-the-road truck fleets on a wide scale basis, they are all installing charging stations for electric forklifts used inside the building.
Market Factors
The big trends occupying the mindspace of industrial occupiers and developers today include a wide array of factors including inflation, the economy, cap rates, interest rates, and numerous others. But Kozarits notes, the cost of capital has had an impact on new construction or lack thereof, but primarily from the speculative development side of the business. “The owner occupiers are affected but it's not going to keep them from building. It's totally different approach,” said Kozarits. “The cost of land is getting outrageously expensive, especially in the major markets.” He said they are seeing easily double-digit land prices up around O'Hare in Chicago, where it is common to see $40- to $50-per-square-foot land sales. By comparison, 30 years ago it was $3 to $4 a foot.
Investor Interest
Industrial is now firmly established as a preferred asset class, whereas in the past “all the money was chasing the big office buildings. When you look at the major downtowns now across the U.S., all those investors that focused on building a portfolio of CBD office buildings, they're wishing they were in industrial right now because those buildings are really struggling,” said Kozarits.
Most institutions have a balance or an allocation of equity that they work to rebalance acquisition goals each year. Kozarits said, “We have seen the percentage of industrial, at least that they're going to try to acquire, is quite a bit higher than what it was just a couple of years ago. And they are obviously shying away from office and retail.” Research by Nareit supports that view. It found that from the beginning of 2010 to the first quarter of 2023, industrial allocations grew from an 8% share of REIT assets to 15%.
Investments are still based on credit term and location. Good industrial product that still has decent term on it is still in the mid-single digit cap rates. If it's a single tenant building with a good credit tenant, there's still a demand for that, said Kozarits.
Interest rates have really put a kibosh on spec development, though. Developers that had projects planned have not moved forward with them. Kozarits said, “Another interesting sidebar on that is developers who never would consider selling a site because they were going to build a spec building on the site, are now considering selling sites. When they acquire land typically it's a floating rate and it's also requires personal guarantees and neither one of those are preferred by a developer. Since the cost of carry has tripled since they bought the dirt, there's going to be some land being sold.”
Rates are not likely to come down soon or quickly, though they’ve likely stabilized as the Federal Reserve realizes inflation is softening. The industrial sector will need to adjust to rates remaining higher for a while.
Fueling the Future
The future of the industrial sector will likely be sustained and fueled by a number of factors. One will be growth and expansion within the cold storage vertical, predicts Kozarits. The explosion within this sector is being driven by consumers, many of whom grew accustomed to not going to the grocery store to do their shopping during the pandemic. “That trend is continuing, and the cold storage segment is adjusting by bringing locations closer to their customers. People have shown they are comfortable ordering online and having their groceries dropped off on their front porch in both urban and suburban markets,” said Kozarits.
That will, in turn, likely change the size of grocery stores. “We are going to see reduced store sizes and refrigerated, and frozen groceries will be housed in 120-foot clear cold storage buildings that are fully automated,” he said, noting that these facilities are significantly less expensive to operate and maintain compared to a traditional grocery store.
Growth Drivers
Given the continued sprawl and demand, growth is expected to occur for both last mile infill locations and regional facilities. Kozarits points out that depending on the purpose of the site, occupancy strategies will dictate location decisions. That encompasses regional distribution locations where the user doesn’t need to build on an expensive land site or in an infill last mile type of location where the occupier will pay a premium for the land because it needs to be close their customer base.
Automated storage retrieval systems are also driving growth. The industry is shifting to a material handling concept to reduce costs and expedite the process. That entails a very tall warehouse that is operated using barcodes and technology. Those elements help reduce the number of employees required to run the facility. That concept is beginning to seep over into the dry storage side, as well, notes Kozarits.
Cold Storage Heats Up
This shift that is under way is bringing in a new metric used by cold storage operators. Typically, FAR, or floor area ratio, is a traditional metric used in office buildings. That equivalent metric is pallet positions in cold storage. The goal is to maximize the amount of storage in a refrigerated or frozen facility, especially in a high-cost land location. That’s typically accomplished by building tall facilities to gain the most pallet positions. Users are charged by the number of pallet positions they occupy, not by square footage. “The more a cold storage operator can fit vertically allows them to increase capacity and generate more “rent” from those added pallet positions,” said Kozarits.
The increased efficiencies and revenue of a warehouse with an automated storage retrieval system also helps reduce the number of employees needed to operate the facility, too. Though there may be 30 to 50 percent fewer warehouse workers in these higher tech facilities, those that are there must be computer literate and typically are higher paid compared to a traditional forklift driver.
Robotics are exploding in the overall industrial sector, not just the cold storage vertical. It is a trend that is here to stay as robots operate in the low loading areas to move pallets into designated positions via barcode systems.
Corporate users are utilizing automated storage systems in the dry buildings, but developers have not fully adopted them yet in a traditional distribution building, which is typically 40-foot clear and not designed for automated storage retrieval systems. “We’re seeing 150-foot-tall cold storage vertical facilities where the spaces are designed to be operated by automated storage retrieval systems.
The reconfiguration underway across the industrial sector will continue to be impacted by the job market, adoption of technologies and a host of broad economic conditions. Strategies such as onshoring and reshoring will also play a role in what tomorrow’s industrial landscape looks like, even as the impact of automated storage retrieval systems move beyond cold storage facilities and work their way into more traditional industrial settings. It all adds up to continued changes, though industrial properties are expected to remain in demand by occupiers, as well as hold a favorable position as a preferred asset class by investors.
