Big Box Warehouse Space Now Officially Worth More than Office Space
Colliers reports continued robust demand for big-box industrial facilities has pushed cap rates down to match urban office space.
The U.S. industrial renaissance has been one of the most surprising and promising developments to emerge in the post-2008 recovery. Unlike most prior recoveries, the U.S. has managed to increase manufacturing employment in the most recent period. Innovation is creating new sources of real estate demand across the spectrum of industrial land use.
On one end, Tesla is building some of the largest manufacturing facilities in the history of the world with gigafactories. The growth of online retailing is driving the construction of the largest logistics and warehousing facilities ever built. For reasons discussed below, big, “dirty” industrial businesses, like chemical processing, are back in the U.S. Domestic and foreign firms alike are starting up new industrial operations, like the Chinese who have already built a more than one billion-dollar chemical facility in the U.S., and many are in the works—including Foxconn’s ten figure manufacturing facility in southern Wisconsin announced last year—with plans to build 10's of billion of more. And in the energy space, massive new American energy export terminals are under construction, mostly along the Gulf Coast, which are also industrial facilities built at awesome scale. These terminals chill and condense liquefied natural gas and store it in huge container ships, for which the Panama Canal was recently widened to accommodate.
On the smaller end of the industrial spectrum, advanced manufacturing facilities are building the next generation of hardware, machinery and robots/drones, but doing so in much smaller footprints. And operating with much less noise, noxious odor and environmental contamination as well—allowing industrial reuse to return to neighborhoods they once threatened in a more harmonious mixed use environment. Compared to the nightmare of life inside the 19th and 20th century industrial city, the possibilities for quality placemaking that incorporates all land uses in today’s world are becoming real.
America’s best-in-class recovery
The United States is getting the best of global recovery in the post-2008 period. The burgeoning fracking boom that began when crude oil ran to nearly $150 per barrel (in the commodity crunch that preceded the real estate crash) blossomed during the Obama administration. It led to a quick doubling of domestic crude oil supplies—bringing more crude oil online in a shorter period of time than any previous oil boom (even larger than Saudi Arabia’s discovery heyday half a century ago when it brought the largest oil field in the world, Gwhar, online).
Importantly, the U.S. carbon boom also brought orders of magnitude of new natural gas supplies online. Thanks to improved technology and high prices, natural gas reserves once economically non-viable suddenly became profitably recoverable. Seemingly overnight, U.S. natural gas import terminals were quickly redeveloped into export terminals. The Obama administration promptly greenlighted a whole new generation of liquified natural gas (LNG) export terminals—enough to more than double the amount of LNG in global trade—and taking the largest, cheapest supply of natural gas from North America to the world.
At the same time, solar and wind prices both experienced substantial declines—with solar down ~80% during Obama’s eight years. As a result, many more renewable projects of large, commercial scale began coming online. And thanks to this multidimensional energy boom, the total U.S. energy resource profile suddenly pivoted from decline and weakness to abundance and strength.
Now the U.S. enjoys the cheapest energy in the world. Its economic rivals are no match for the breadth and depth of the U.S. energy advantage. For many years now, the price of industrial electricity in the U.S. has been roughly half the price of electricity an industrial user will pay on average in the EU. For many industrial companies, who are large power users, the U.S. electricity discount is too attractive to resist.
And so for many years now, since taking the top spot in 2012, the U.S. has been the top destination for global capital investment according to an annual survey performed by AT Kearny.
This pivot towards industrial reinvestment within the U.S. and foreign direct investment (FDI) into the U.S. help drive industrial production to record heights. Never before has the U.S. industrial economy produced more total “widgets” than now. Combined with multiple thriving segments in the energy sector and a strong consumer, the U.S. recovery has been the envy of its economic rivals.
There is a top to bottom, full spectrum reinvention happening now in every segment across the board. Residential, commercial and industrial forms are evolving with technology and society. Neighborhoods are being redesigned with greater amenity, pedestrian features and additional density. Malls, retail stores and grocery stores are being reformulated to match the new demands of the modern consumer. And beyond those advanced manufacturers setting up smaller shops in urban areas, the entire delivery system is being redesigned because of Amazon’s race for scale (plus new possibilities for the cold-storage supply chain).
We’re now several years past the introduction of Amazon Prime in 2013, which shifted the decades reliable holiday shopping season’s peak shipping by more than a week forward. Taking notice of the substantial meaning event at the time, Howard Schultz (the CEO of Starbucks at the time), called it a “sea change.” He began Starbucks’ fourth quarter investor conference call by declaring:
“The truth is that traditional brick and mortar retailing is at an inflection point. No longer are many retailers only required to compete with stores on the other side of the street. They are now required to compete with stores on the other side of the country. ...many, many retailers who are going to have a hard time navigating through what I believe will not be December-ish problem, this is going to be an ongoing issue and it’s going to happen faster than people think in terms of the way people are shopping and how they are spending their time, and the value that you can get on the web.”
Since that time, between 2013 and 2017, real estate developers added ~848 million square feet of warehouse space—almost 3X the ~300 million square feet built over the five previous years.
It was preceded by a massive investment in logistics infrastructure by Amazon and shippers, but it would not be enough. There were shipping failures in 2013 as a result of the disruptive surge. And there have been major shipping failures in most years since during the holiday shopping season.
Such is the strength of the U.S. consumer and the growth of e-commerce. The U.S. has now enjoyed it’s fifth record-breaking holiday shopping season in a row, each year coming in 4-5% bigger than the year before. As BL noted previously, industrial production and retail sales both hit all-time record highs in the fourth quarter.
No surprise then perhaps, that last year that the average price for U.S. industrial land doubled according to CBRE.
Warehouses on fire in the best way possible.
The U.S. industrial sector was essentially forgotten by the broader real estate world. After decades of underperformance, industrial land, warehousing and logistics have found an incredibly sweet spot and industrial landowners (especially warehouse owners) should be ecstatic about their position in the market. Demand is at a generational high and supply of shovel-ready, infrastructure-enabled sites is low. Rooted in strong, structural forces likey to last through a new economic long cycle, industrial real estate is waking up from its long sleep up in a Goldilocks environment.
As Colliers International Group Inc. (Colliers) explains in its report:
By “big box,” Colliers is referring to the new, high-tech warehouses having at least 200,000 square feet and a minimum of 28-foot ceilings. They are primarily used for distribution and built with pre-cast or tilt-up concrete construction.
Amazon is using more industrial space than anyone else in the U.S. The company seemingly bigger than its namesake rainforest now operates 100+ million square feet spread over 258 facilities and plans to add 37.8 million more square feet by the end of this year. The report notes that “nearly every market can attribute some level of growth in the industrial sector to Amazon.” In Cincinnati, Amazon invested in its first Amazon Prime Air hub—a $1.5 billion investment into 900+ acres at the Greater Cincinnati/Northern Kentucky International Airport, which is not the biggest, but the fastest-growing cargo hub on the continent. “Being able to reach 65% of the U.S. population within a day’s drive positions Cincinnati as a key location for logistics operations,” said John Gartner, Brokerage Senior Vice President & Principal at Colliers Cincinnati.
But it’s not a one horse race. Amazon’s competitors, chief among them Wal-mart, are modernizing their own supply chains to keep up. As the entire consumer economy adjusts to the internet’s possibilities and consumer’s changing behavior, it is cascading through the entire real estate ecosystem.
In the industrial space, the race for the future of logistics and front-door delivery is combing with new demand from the energy revolution and adding up to record industrial demand. Colliers new report details a recent surge in the value of industrial property. In an interactive online report, Colliers breaks down the strengths of the North American big-box industrial market in 2017.
Colliers examines the seven core North American big-box markets (including the Inland Empire, Atlanta, Dallas-Fort Worth, Chicago, Northern-Central New Jersey, Eastern Pennsylvania-Southern New Jersey and Toronto), as well as seven emerging secondary markets. The report runs through 2017 fundamentals by looking at demand factors including demographics and logistics capabilities. In sum, the report notes, “a variety of factors across North America are fueling continued robust demand for big-box industrial facilities. Core markets… continue to post robust fundamentals.” But in the continuation of a rotation trend noted by BL in a previous forecast, “the largest growth is in emerging secondary markets near the fastest-growing population centers, and most utilized logistics hubs in the region,” the report points out.
Warehouses are so hot, they’re now worth more than offices.
And as Bloomberg notes, the demand for this ‘big box’ real estate has stayed so strong in the coming of age of e-commerce that it’s actually caught up and surpassed most commercial office space. Even high priced office space in urban markets are essentially even money with big box warehouse space.
Whereas Colliers’ report found that such warehouses sold in 2017 at an average capitalization rate of 5.8%, the cap rates for U.S. office space in suburban and rural properties are almost a full percent higher at 6.7% (and therefore lower in price). In urban cores and central business districts, generally with the more highly priced, high class assets, the cap rate is only slightly lower than warehouse space at 5.7% percent.
At the same time China’s began slamming the brakes on U.S. commercial real estate investment (down 55% in 2017), suburban office clusters are losing tenants to urban markets and the brick-and-mortar retail slow motion apocalypse continues apace, the boring and abandoned industrial sector’s performance is outpacing them all.
Long into a historic economic expansion, a slow down must come. A trade war, rising interest rates or a combination of many factors may contribute to a cool down period for a historically hot economy. New long term fundamental trends remain in place, but as Colliers cautions:
Larry Feinstein, chief executive officer of Hire Dynamics, recently told Bloomberg the local labor market was already tight when Amazon.com Inc. opened a 1,000-person fulfillment center in one particular county last year. “Amazon comes in and sucks up all the labor,” Feinstein reportedly told Bloomberg, whose recruiters are scrambling to hire 40 people a day for a warehouse operated by Carter’s Inc., a maker of baby and children’s clothing. “Every one of our clients up there has raised their pay rates at least $2,” he said.
Workers are coming into stingingly short supply. What began several years ago as labor shortages in some skilled labor categories has spread to seemingly every segment. “We almost don’t have enough people with low skills to fill all the need in the fulfillment industry,” Don Cunningham, who heads the Lehigh Valley Economic Development Corporation, told Bloomberg.
The Lehigh Valley corridor that straddles Pennsylvania and New Jersey has been one of the focal points of the logistics surge in recent years. Employment in e-commerce and distribution centers grew by 10,000 over the last five years alone. Bloomberg notes that the industry is almost employing as many people as the manufacturing sector, historically the largest employer in the Lehigh Valley corridor.
But as land supply shrinks and land prices surge, the size of the new logistics warehouses have only grown larger—as we noted above, today’s warehouses are the biggest ever built. And, as Bloomberg points out, this has pushed many distribution centers to the edge of population centers—creating an unwelcome negative logistic for many of the employees of these logistics hubs. As Bloomberg notes, “Employees who used to drive from 25 miles out are now having to commute from as far away as 40 miles—a long haul for someone making $12 an hour.”
Amazon, now with fulfillment centers across the U.S., has recognized the strain and is running shuttles for employees at some locations and hands out gift certificates to those willing to carpool. Seen as a good jobs, people are generally willing to put up with long drives and intense performance pressure—though calls to improve labor conditions at Amazon are growing. Stories like a recent report that Amazon warehouse workers in UK 'peed in bottles' over fears of being punished for taking a break seem likely to add to the chorus of critical voices.
But the logistics have come hard and fast—and still suffered delivery failures in most of the holiday shopping seasons over the last 5 years (partially due to weather as well as surging package shipping). And with the labor pool only tightening and the market for available land at suitable scale tightening even further, Amazon looks to be managing these constraints long over the horizon.
Still, these are growth problems. And growth problems are better to have than the alternative As Colliers concludes rather constructively:
Investors have taken note and the age of industrial underperformance is dead. As Bloomberg quipped separately:
“Forget your fancy office towers. The future lies in warehouses. But not just any old dusty depot. It’s got to be big enough, smart enough and close enough to consumers. Pick right and you could beat the returns of every other kind of property this year.”
And because online retail still amounts to less than 10% total U.S. retail sales, there are millions and millions of miles of square feet to go. Industrial land prices may be rising to new all time highs, but we’re still in the early innings of building out the 21st century consumer economy. It might take a generation to completely reconfigure supply chains—with several recessions along the way. Proclamations of the death of productive industrial land use in the U.S. were premature, though it lay dormant for a long sleep. Industrial landowners are now forging a new destiny. New forms of demand are emerging everywhere and the course of many of these emergent “cleantech,” “zero waste,” “closed loop” technologies seem clearly set to compound the need for contemporary industrial real estate as far as the eye can see.