Logistics & Supply Chain: Where is the Industrial Sector Going Next?

Industrial space remains in high demand and holds a premium position among all commercial real estate asset classes — for both occupiers and investors. The property type is a top performing sector, generating outsized returns, largely driven by voracious tenant appetites for more space. That has worked to attract interest from even the most sophisticated and discerning investors — institutional investors. Now, after several years at the front of the pack, prospects remain elevated and industrial is a “must have” asset in a real estate portfolio, pushing the sector into the next phase of growth.

Significant factors driving the industrial segment are e-commerce growth, the introduction of new technologies and advanced manufacturing techniques, onshoring and reshoring practices, as well as the emergence of “industrial as retail” strategies. The coming year promises to be one in which these elements will positively impact the industrial market and offer glimpses of where the industry is headed.

In 2022, more than 480 million square feet of industrial space was delivered across the country, setting a new industry record. That elevated development activity was fueled by demand that continued to outpace supply. National industrial in-place rents averaged $0.59 per square-foot per month, up 6.3% year-over-year. Meanwhile, the national vacancy rate contracted 180 basis points in 2022 as new deliveries were absorbed at a rapid pace.

Real Capital Analytics reports that more than $118 billion of industrial sales occurred last year. While robust, it was 18% below the 2021 total of approximately $143 billion. Western markets posted seven of the 10 highest sale prices nationwide, all seven of which were in California.

Supply Chain Reconfiguration

Demand from e-commerce companies has helped reconfigure the market as supply chain and logistics firms continue to drive record demand for new space. The ongoing quest by retailers to meet consumer needs as quickly and efficiently as possible has opened the door for logistics and fulfilment operations to take space in facilities that are highly functional and allow them to deliver orders when requested. A modern supply chain is dependent on moving products rapidly in the shortest delivery time, which is why facilities at infill locations are coveted and experiencing rising values.

There has also been an increased shift in demand for industrial space by companies that can now deploy new technologies and take advantage of expanded chip capabilities for such uses as autonomous vehicles, robotics, or sensors. They tend to favor industrial spaces with flexible zoning that can accommodate multiple uses such as office, assembly, warehousing, and manufacturing. Companies are also increasingly capitalizing on new advanced manufacturing and 3D printing features that can be housed in much smaller footprints today than what they could in the past. These advanced manufacturing techniques are emerging as a major driver for tenant demand.

Supply chain disruptions that resulted from the pandemic and the shortage of semiconductor chips caused changes in the manufacturing sector that are evident today. For instance, the US dependence on Chinese manufacturers was clear as lockdowns led to a global shortage of the high-tech chips. The impact was felt in everything from car manufacturing to smartphones. The fragility of the global supply chain was exposed primarily because it relied too heavily on one region. Companies can operate more nimbly when issues arise by adopting a more regionalized model that features a diversified footprint, which is a trend industrial industry experts expect to continue for years.

These shifts to diversify risk now may encompass manufacturing or sourcing in multiple countries or with more than one company, which can help reduce supply chain interruptions. Companies are now more frequently finding ways to reduce the complexity of a global supply chain for transit times and freight costs by locating operations for manufacturing or sourcing near end customers.

Adoption of Onshoring & Reshoring

Perhaps one of the biggest emerging trends impacting the industrial market is an increase of reshoring and onshoring in the US in an effort to improve sourcing strategies and make supply chains better suited to handle shocks. Global supply chains proved vulnerable to factors that fell outside of a company’s control, whether that be an issue impacting a supplier — such as a local labor issue, a natural disaster, or a global health pandemic.

Companies across a host of industries are adopting strategies that involve either locating suppliers or production facilities nearby its home base to gain more control. Or they are spreading facilities out geographically to diversify risk across more locations, which allows them to be less dependent on just one site. These endeavors are envisioned to create fewer disruptions and enhance business continuity. The approaches are showing up in a recent surge of domestic reshoring activities, too. A survey of US and European manufacturing companies last year showed that roughly 60% say they plan to reshore at least a portion of their Asian production in the next few years.

Last year, US companies reshored nearly 350,000 jobs, representing a 25% increase from 2021, according to research by Deloitte. US companies, ranging from General Motors to Intel and US Steel, increasingly have been returning their manufacturing operations stateside. More than 1,800 companies reshored their productions last year, according to a report from the nonprofit Reshoring Initiative. Beyond manufacturers, several retailers like Walmart, consumer brands like Apple, or car companies like Volvo are embracing domestic reshoring approaches — some to avoid disruptions and others to reduce costs such as high shipping costs.  According to Kearny’s 2021 Reshoring Index, almost four of five companies have already shifted production to the US and at least 15% are considering it due to high tariffs and ongoing supply chain challenges.

Large manufacturers have worked to adjust their approaches by adopting the practice of onshoring. In fact, there has been a rise in new manufacturing plants being built in the US, including those for such products as electric vehicle batteries and semiconductor chips. Beyond de-risking, the practice of reshoring and onshoring to the US is helping boost demand overall for the light industrial product type, since the industrial tenant base is often composed of vendors that support manufacturers.

Incorporating New Technologies

New technologies are also influencing the way companies operate, providing enhanced perspectives on supply chains. Before the pandemic hit, it is estimated that more than 50% of companies lacked established channels of communications with suppliers. That made it difficult or virtually impossible to talk with suppliers on a regular basis, and companies really didn’t have a grasp of where their suppliers were located — which of course contributed to the challenge of anticipating and adapting to shortages. Now, more modern digital technologies from software and cloud computing to artificial intelligence tools or robotics are resulting in numerous benefits like improved communications, more efficient data storage, smarter decision-making, and automating processes.

The “just-in-time” supply chain approach needed to be adjusted to a practice that also embraces “just-in-case” because the “just-in-time” model made businesses vulnerable to even small disruptions. The pandemic-induced disruptions were significantly amplified into big issues across a lean supply chain. Companies now may carry more inventory in their supply chains to reduce the risk of shortages, though it must be balanced against the increased costs, excess stock, or product obsolescence. It was a hard lesson to learn that the cost of empty shelves was greater than having no product to sell due to supply chain inefficiencies.

Overall, 2022 was a banner year for the industrial market, and 2023 is projected to remain strong, primarily due to the high demand for e-commerce-focused distribution space and limited supply in most markets. However, several factors will provide challenges for industrial tenants going forward, including elevated inflation, persistent supply chain delays, increased labor costs, a slowdown in global production, and a decrease in container traffic at the ports. These considerations, coupled with industrial rents escalating to an all-time high, have already made it more challenging for many industrial tenants to keep rising operational costs in check. We are seeing this as more sublease space is beginning to hit the market as some tenants have looked to reduce real estate and operating costs.

Clearly, the industrial asset class is no longer hidden in the shadows of other commercial real estate property types though. It is expected that tenant demand for more space will continue to drive the industrial market as premiums are placed on infill locations to better serve customers. That nearly insatiable appetite for industrial space hasn’t escaped the notice of institutional investors that covet the potential returns generated by these assets. Those factors promise to continue driving growth across the industrial segment into the future.

Contact

GARY BARAGONA
Director of Research
415.229.8925
gary.baragona@kidder.com

Sources

CoStar, Kidder Mathews Research, Real Capital Analytics, Deloitte