REALITY CHECK EVALUATING 7 INDUSTRIAL REAL ESTATE PREDICTIONS Cushman & Wakefield Research
As the U.S. economy started to creep down the road to recovery, fundamental shifts in retail shopping patterns and manufacturing strategies were beginning to manifest themselves in the industrial landscape. Conversations in the supply chain and real estate industries began to focus on the emerging trends likely to shape the next few years. A variety of industry watchers and media outlets contributed to the buzz, and we made our own predictions about which trends would likely bring wide-reaching, lasting changes and which were likely to be short-term blips.
So how closely have the prognostications played out? Where have industry analysts hit the mark and what surprises have emerged? In this report, we take a look back at SEVEN predictions about industrial real estate, the impact of e-commerce, shifting consumer behavior, the reshoring of manufacturing, and the shifts in facility location and design. We assess how closely the industry has tracked according to predictions and continuing forecasts, and we highlight the trends that are worthy of continued consideration as companies address their supply chain strategies.
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3
THE NEW RETAIL PARADIGM
5
INCREASINGLY URBAN
7
BIG IS IN
9
RAISE THE ROOF
11
BRANCHING OUT
13
RISING PRICE TAG
15
ALL ASHORE
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THE NEW PARADIGM
Shopping and buying patterns are changing. In the U.S, 62% of consumers now make a purchase online at least once a month. The growth of online retail sales as a percentage of total retail sales is showing no signs of slowing. Forester Research Inc. projects it will reach 11% by 2018, up from about 8% percent today. This new paradigm presents unique opportunities and challenges to both retail and industrial formats. Since the Great Recession ended, the delivery of new industrial space has rebounded. The more than 160 million square feet (msf) projected to be added by the end of 2014 will be the second highest total in the U.S. since 2002. But the story is markedly different in the retail sector. In 2007, nearly 210 msf came online in the U.S. Each of the last four years has seen less than a quarter of that volume delivered, and through mid-year 2014, just over 20 msf had come online.
PREDICTION
E-commerce growth will outpace growth in overall retail sales, causing fundamental shifts in order fulfillment strategies and models
STATUS CHECK WAIT & SEE
WAY OFF
ON TRACK
While new retail development has slowed, some existing retail inventory is being transformed. According to Green Street Advisors, about 15% of U.S. malls will be converted into non-retail space or will fail entirely within the next 10 years.
The shift in how people are shopping means the future of retail fulfillment is no longer just about more stores or shopping centers. The new retail eco system will require more warehouses (many of them highly specialized), different methods for the delivery of purchases, and new hybrid fulfillment center formats. THE CHANGING ROLES OF THE STORE & DISTRIBUTION FACILITY
Though the physical store will continue to be a primary component of retail sales, the relationship between stores, distribution facilities and the end customer is being transformed because consumers want a variety of fulfillment options.
Direct to Customer (D2C) models—parcel carriers delivering online purchases to the customer’s doorstep—is well established. But formats like Buy Online Pick Up in Store (BOPUS), Ship from Store (SFS) and others will play an increasing role. These and other changes will only accelerate as e-commerce adoption climbs.
67% OF ONLINE SHOPPERS SAY BEING ABLE TO PICK UP ORDERS AND RETURN PRODUCTS IN STORES IS IMPORTANT TO THEM
67%
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PERMANENT SLOWDOWN?
A consistent decline in retail store foot traffic suggests shoppers are taking fewer visits to physical stores and spending less time there. At the same time, some traditionally online-only retailers are opening bricks and mortar locations. Warby Parker, Birchbox, and Amazon are recent examples. This strategy underscores how retail space is transforming and being repurposed with an increasing emphasis on experience and branding, amplifying the importance of the right store location.
NOV. & DEC. TOTAL RETAIL FOOT TRAFFIC
(BILLION VISITS)
NEW RETAIL SPACE DELIVERIES
(MILLION SQUARE FEET)
250
40
200
30
17.6
150
20 100
20.3
10
50
AT MID YEAR
0
0
2010
2011
2012
2013
2007 2008 2009 2010 2011 2012 2013 2014
NOTE: Traffics data is collected from 60,000 traffic-tracking devices installed at malls and large retailers. Retail space is for selected markets tracked by Costar Group. Sources: ShopperTrak (visits); Retail New Deliveries: Costar Group
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URBANIZATION EFFECT
PREDICTION
To meet e-commerce service expectations for a new kind of shopper, DCs will be located closer to urban centers
As delivery evolves from two- to three-day models to one-day and same-day delivery, facilities are frequently being clustered closer to population centers. Take the example of e-commerce fueling new DC projects in major regional distribution hubs like Dallas, the Inland Empire, and Chicago, which have 16.0 million square feet (msf) 13.4 msf, and 11.1 msf under construction respectively. Each of these markets recorded more than 8.0 msf of e-commerce deal volume during the last three years. The New Jersey market registered the highest percentage of total activity (deals in excess of 200,000 sf) for e-commerce since 2011, not surprising given the market’s proximity to large population centers.
STATUS CHECK WAIT & SEE
WAY OFF
32% ON TRACK
32% OF TOTAL ACTIVITY >200K SF IN NEW JERSEY SINCE 2011 HAS INVOLVED E-COMM FACILITIES
INFILL DEMAND & SMALLER BOXES
While big box DC construction has been the most visible e-commerce story lately, it’s not the only one. Demand around the edge of major cities for smaller infill facilities is on the rise, a response to the increasing trend toward sameday fulfilment. Not only do companies covet the proximity to FedEx/UPS ground-shipping centers these locations often bring, proximity enables them to fill and deliver orders to a large number of customers quickly.
Competition for smaller format DCs in infill locations is likely to continue to increase Multiple smaller- and mid-size distribution centers that are well-placed in urban infill locations minimize the time and distance spent on the ‘final mile’ leg of delivery. Such centers are being used by major retailers as satellite locations, or by small and midsize companies as primary online fulfillment centers. OnTrac, a regional overnight package delivery service, is one such company taking up space in these types of locations. OnTrac recently leased a 100,000-sf facility in Santa Ana, California to distribute to the coastal communities of Orange County. OnTrac also operates a 400,169-sf central regional hub in the Commerce submarket of Los Angeles that feeds out to other smaller locations.
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NOTES FROM THE FIELD
Currently Amazon can reach 15% of the U.S. population with same-day delivery. But if it can place fulfillment centers nearer to the top 20 U.S. metropolitan areas, it could reach 50%, according to supply chain consultants MWPVL International. Amazon is actively working to achieve this goal. Although land costs in urban areas will likely make the investments more expensive, savings in shipping rates may offset the higher costs over time. In August 2014, Amazon announced that it expanded same-day delivery for customers in Baltimore, Dallas, Indianapolis, New York City, Philadelphia and Washington D.C. metro areas. These locations expand the “Get It Today� service already available in metropolitan Los Angeles, Phoenix, San Francisco and Seattle. The Home Depot has also increased focus on e-commerce, launching a major upgrade of its fulfillment processes to support anticipated double-digit online sales growth. It recently opened the first of three new direct fulfillment centers (DFC) designed to speed online orders to consumers through distribution channels across its supply chain. The three DFCs will deliver 90% of online parcel orders within two days using ground service. The Home Depot will spend $300 million this year on the fulfillment centers, mobile technology, facility enhancements, and warehouse management systems.
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BIGGER FACILITIES IS THE TREND
Industrial buildings are setting new size records. The average warehouse/distribution facility in the U.S. is 42% larger than it was in 2000. And mega-sized distribution centers greater than 1.0 msf are becoming more prevalent in several markets. Of the total inventory of buildings this size, half were constructed after 2000, with a quarter of the total inventory added since the beginning of 2007.
PREDICTION
Warehouse/Distribution centers will continue to grow bigger
STATUS CHECK WAIT & SEE
The need to improve supply chain fuel efficiency is a driving force behind the rise of the new mega development. These giant facilities allow companies to experiment with different fulfillment strategies and respond to the demands of high-turnover online retailing.
Siting these mega DCs comes with its own challenges. The facilities and the operations within them often require large land parcels to accommodate larger truck courts and parking areas. Locating close to UPS and FedEx hubs is also vital to meet direct-to-consumer delivery demand. Amazon, Procter & Gamble, Pepsi, Home Depot, and Walmart are some of the prominent brands building these facilities. The largest 2014 completions include a 1.7 msf location for P&G in Pennsylvania, and two separate 1.5 msf facilities in California and Texas. Michelin North American recently announced a 1.7-msf build-to-suit in Chicago to be completed in 2015 while Walmart has three new facilities of over 1.1 msf each in the Lehigh Valley, Inland Empire, and Indianapolis.
U.S. AVERAGE SIZE OF WAREHOUSE/DISTRIBUTION FACILITIES
181,370 SF WAY OFF
ON TRACK
65,000 SF
PRIOR TO 2000
127,500 SF
2000 - 2006
2007 TO PRESENT
Source: Cushman & Wakefield Research
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The Home Depot’s 1.6 million square feet of distribution space at the CenterPoint Intermodal Center in Joliet, Illinois exemplifies the current trends in logistics facility design. This build-to-suit development serves as the company’s Stocking Distribution Center. Combined, the 180-acre logistics campus will have more than 2.2 million sf under one roof.
Photo: CenterPoint Properties
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SKY’S THE LIMIT? As warehouse distribution buildings have been expanding out, their ceilings have been going up. Direct-to-consumer sales require retailers to consolidate online and store-based fulfillment operations under one roof, which is spiking the demand for high-tech, big-box facilities. The higher ceiling height improves racking options and maximizes pallet capacity by 12% - 25% in comparison to 32’ clear height. The higher formats increase cube capacity by 7% -15% as well. Beyond the operational benefits, the higher ceiling height also may provide some tenants real estate benefits, enabling expansions in the same facility in
some cases, thereby maximizing square footage and providing a market option that doesn’t require relocation. The majority of these new mega facilities are buildto-suits. Yet developers are getting in on the act by building speculative product to higher specifications, responding to both current and anticipated demand for this type of facility. In the Inland Empire, five new speculative construction projects are under way that feature 36’ clearance. Dallas/Fort Worth is another market where the trend is visible. Seven new spec projects totaling 7.2 msf offer clear heights greater than 36’.
PREDICTION
Clear heights will continue to rise as fulfillment facilities require more sophisticated levels of automation and efficient use of space
STATUS CHECK WAIT & SEE
WAY OFF
ON TRACK THE 36’ CLEAR ETIWANDA COMMERCE CENTER, ONTARIO, CA
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Two other factors pushing DCs from 30’-32’ to 36’- 40 are mezzanine requirements and increasing adoption of automation. Mezzanines support fulfillment center order picking. Automation is increasingly seen as a way to address the challenges of fulfillment labor, speed, and accuracy. Rebounds in the housing and automotive sectors and expansion in industrial, warehouse and commercial development appear to be driving growth in Material Handling Equipment Manufacturing (MHEM). After a slowdown in 2013, data show 2014 with strong increases in both orders and shipments of material handling equipment.
MATERIAL HANDLING ORDERS
12 10 8
10.0% 7.7% 6.0%
6
MATERIAL HANDLING EQUIPMENT SHIPPING
DOMESTIC DEMAND GROWTH
12
12
10
9.8%
9.1%
8
6
6
4
4
2
2
2
0
0
0
2012
2013
2014
2012
2013
9.5%
10
8 3.5%
10.9%
3.4%
4
2014
2012
2013
2014
Domestic Demand is defined as shipment of material handling equipment, plus imports, minus exports. SOURCE: MHI/Material Handling Industry of America. 2014 numbers represent expected results.
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CORE MARKETS CONTINUE TO LEAD
Although it’s true that secondary markets have seen an increase in development, activity in primary markets has been stronger, particularly in core markets like the Inland Empire, Chicago, Dallas/Ft. Worth, Houston, and Central New Jersey. But if top markets aren’t constrained yet, that scenario may not be far off. Companies seeking good highway access, proximity to intermodal or ports, and strong labor are finding it increasingly difficult to secure sites in top markets that meet the location criteria. Limited availability and high land prices are making urban facilities more expensive, and neighboring submarkets are becoming more and more land-constrained in many top markets.
PREDICTION
Demand for large, modern warehouse space will outweigh supply in primary hubs, pushing activity into secondary markets
U.S. INDUSTRIAL CONSTRUCTION COMPLETIONS
STATUS CHECK
300,000,000 250,000,000
WAIT & SEE
ON TRACK
SQUARE FEET
WAY OFF
200,000,000 150,000,000 100,000,000 50,000,000
0
2007-2008 Primary Markets
2012-2013 Secondary Markets
Some markets will likely see older stock demolished to meet part of the demand. But markets that have ample land ready for construction like Phoenix, Salt Lake City and Indianapolis could be the beneficiaries of spill over. MATURATION OF MARKET CYCLE GOOD NEWS FOR SECONDARY MARKETS?
During the last significant real estate cycle, we saw the top 10 U.S. markets hit a delivery peak, collectively representing 83% of total completions in 2006. Subsequently, that percentage fell to 67% as the cycle bottomed out in 2009. Now the trend is reemerging. In 2012, as a percentage of total construction completions, the top markets hit a delivery peak of 81%. Fast forward two years and that percentage has fallen marginally to 75%, suggesting that as the business cycle matures, more development capital looks beyond primary markets.
PRIMARY MARKETS * ATLANTA CHICAGO DALLAS/FORT WORTH HOUSTON INLAND EMPIRE LOS ANGELES MIAMI NEW JERSEY PA I81/I-78 CORRIDOR PHILADELPHIA *As defined and tracked by Cushman & Wakefield Research. Only markets tracked by C&W offices are included in this analysis.
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REPURPOSING SITES
In many markets with extremely tight conditions, a combination of strong fundamentals and an easing of financial underwriting criteria have motivated some investors to demolish obsolete stock and replace it with new speculative developments. In Los Angeles the largest new development is KTR Capital Partners’ 620,000-sf spec project at the site of a former paint factory built in 1942. In Oakland, KTR recently purchased a nearly 50 year old 212,000 sf manufacturing building which it intends to demolish to build a new 270,000-sf warehouse. In Denver, another tight market, IBC Holdings and Long Wharf Partners just renovated a 900,000 square foot former Avaya industrial campus built in 1970, repurposing just over 500,000 sf into warehouse space with room for future development. In October 2009, Pioneer 360 Business Center became the largest and one of the first LEED Gold Certification core and shell industrial projects in the state of Texas. More than 95% of steel, concrete, asphalt, copper and aluminum coming from the demolished mall was recycled—some 91,634 tons of materiel. The project also earned the necessary LEED points for community connectivity and infill redevelopment.
Coleman Demolition by Lane Pearman
CC By 2.0 CUSHMAN & WAKEFIELD
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MULTIPLE FACTORS IN RISING COSTS Construction costs for industrial product vary by city and market. Chicago, Northern and Central New Jersey, Los Angeles, and Northern California are among the most expensive. New York/New Jersey and Chicago saw the most significant increases (10% and 5% respectively) in average costs in the last year. These escalations are mainly due to rising labor costs and land constraints, but the imbalances of supply and demand for industrial facilities is also having an inflationary impact.
PREDICTION
Construction costs, construction labor supply and growing product demand could present challenges to progress, both for developers and end-users
STATUS CHECK WAIT & SEE
WAY OFF
ON TRACK
Material costs for construction of warehouse/distribution projects have generally inched upward in recent years. Most projects now use precast concrete. But steel, lumber and dry wall also factor into the total costs. Of these materials, cement and concrete have seen a 0.7% price hike since February 2013 after slightly dipping the previous two months. Steel prices have been essentially flat during the same time period, according to ENR’s 20-city average price survey for wide flange and I-beams. Lumber and drywall costs saw a slight downtick. As the size of the site and building increases, some hard costs on a psf basis (site work, foundation premiums, offsite improvements, shell) may see notable drops. According to Oltmans Construction, the building cost for a 1.0 million sf CTU building with 32’ clear and ESFR sprinkler system can be approximately $21.25 psf in Southern California, compared to $30.00 psf for a 200,000-sf building.
WHERE ARE COSTS HEADED? With construction labor costs having risen 2.8% in the last year and demand for industrial product at a recent high, we expect overall development costs to continue moving up. Simple matters of supply (or lack of construction labor supply for some markets) and demand (for more buildings, varying in size and markets)—paired with inflation, material costs, and land constraints—are a recipe for near-term challenges in meeting new industrial product construction needs for some markets.
IN SOUTHERN CALIFORNIA, CONSTRUCTION COSTS FOR LARGER BUILDINGS CAN BE MUCH LOWER ON A PSF BASIS 1.0 MILLION SF
$21.25 psf
200,000 SF
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BUILDING COST INDEX 1,000
15.0%
900
10.0%
BUILDING COST INDEX
5.0%
700 0.0% 600 -5.0%
500
-10.0%
400 300
ANNUAL PERCENTAGE CHANGE
800
-15.0% 2001
2002
2003
2004
2005
2006
2007
Average Index Building Cost Index
2008
2009
2010
2011
2012
2013 1Q14
%Annual Annual%Change Change
Source: Turner Construction Company. The Building Cost Index measures costs in the non-residential building construction market in the United States and is determined by the following factors considered on a nationwide basis: labor rates and productivity, material prices and the competitive condition of the marketplace.
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NORTH AMERICAN BOOMERANG While there is still a debate about how much reshoring is actually taking place, there's no doubt it is happening, and companies are at the very least examining their options more closely. While the reshoring trend is gaining traction in North America, it’s not limited to the U.S. Not long ago, labor cost advantages of China and India made them prime candidates for outsourced operations. Now locales like Mexico, Canada or the Southeastern U.S. are getting stronger consideration.
PREDICTION
Reshoring will bring more jobs, capital investment and demand for industrial space back to the U.S.
STATUS CHECK
In a 2012 Boston Consulting Group (BCG) survey, 37% of U.S. manufacturers with sales above $1 billion said they were considering shifting some production from China to the United States. Of the very biggest firms with sales above $10 billion, 48% were considering reshoring. The factors respondents cited include rising wages and benefits in China (the Chinese government has set a target for annual increases in the minimum wage of 13% until 2015), as well as stricter labor laws and more frequent labor disputes and strikes.
WAIT & SEE
WAY OFF
ON TRACK
48%
NEARLY HALF OF COMPANIES WITH SALES OF MORE THAN $1B ARE CONSIDERING RESHORING ALTERNATIVES
In 2004, 11 of the top 25 export nations had lower labor costs than the U.S. That number has since fallen to 9. OTHER FACTORS Beyond rising wages in off-shore markets, other supply chain costs and challenges are factoring into companies’ supply chain and manufacturing strategies. This shift indicates manufacturers are looking at and calculating the total costs of off-shore operations more closely. A 2013 survey by the National Association of Manufacturers highlights many of the reasons why companies are reevaluating their strategies. Although rising labor was most cited, other frequently mentioned reasons include the following: • • • • •
Supply chain uncertainty Rising transportation costs Increased U.S. labor productivity Currency volatility Intellectual property concerns
BCG projects that as soon as 2015 it will cost about the same to manufacture goods for the U.S. market in the U.S. as it does in China for many industries including computers and electronics, machinery, appliances, electrical equipment, and furniture. That calculation takes into account a wide variety of direct costs, including labor, property and transportation, as well as indirect ones such as supply-chain risk.
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RECENT RESHORING EXAMPLES
NOTES FROM THE FIELD
The companies listed below are among those that have moved manufacturing operations back to the U.S.
APPLE DIGITAL INNOVATIONS ELECTROLUX FAROUK SYSTEMS FOXCONN
GE GOOGLE LIGHTSAVER TECHNOLOGIES MOREY CORP. NCR
NEUTEX SEESMART SUAREZ CORP (SCI) WHIRLPOOL ZENTECH
Factors noted on the previous page, as well as shifts in consumer demand for faster design order cycles and trends in mass customization, were behind Apple’s recent initiative to bring some manufacturing back to the U.S. In 2013, the company started building the new MacBook Pro models in Austin, Texas. This $100-million investment creates a closer-tohome supply chain that will have a ripple effect on local economies as it attracts clusters of suppliers and workers with specialized skills. Components are made in Illinois and Florida, and the Macs will rely on equipment produced in Kentucky and Michigan. Apple isn’t the only example. Electrolux selected Memphis to locate a new 750,000-sf plant. In the Fall of 2013, production of Electrolux and Frigidaire cooking ranges and ovens began rolling off the line. The plant employs 550 people and 700 more will be added in the next five years as production increases. Electrolux invested $100 million in the plant. GE has moved some appliance production from China and Mexico to Louisville, partly to reduce shipping costs and respond faster to demand, and because of the narrowing gap between U.S. and Chinese wages. As a result, GE has doubled its workforce in Jefferson County, Kentucky to about 6,000 since 2009.
*Flags signify the origin of the reshored operation
For its part, Walmart has pledged to support the revival of domestic manufacturing by spending $50 billion through 2023 on U.S.made goods
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OVERALL ASSESSMENT Clearly several industry predictions are playing out as anticipated, though a few remain fluid. And even though it appears we missed the mark on costs and constraints in primary markets and the subsequent impact on secondary markets, it has been encouraging to see overall demand for industrial space strong enough to power right through many of these concerns.
SO WHAT’S NEXT? As e-commerce adoption continues to grow at about 15 percent annually, and as manufacturing continues to be more costand service-justified in locations where demand is strong (like here in the U.S.), it seems likely that the market for industrial space will remain resilient. The shopping and retailing evolution, shifting demand and service paradigms, current demographic market forces, and global growth dynamics will continue to fuel growth in industrial real estate. While no one can be too sure how long this current economic expansion will continue, these factors will likely drive the development of industrial real estate faster than other property classes—a prediction to assess down the road.
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NORTH AMERICAN INDUSTRIAL CONTACTS Cushman & Wakefield's industrial brokerage platform provides global resources and local expertise for tenant and landlord representation, disposition and acquisition services, transaction management, and industrial consulting including labor and demographic analysis. In the U.S. alone in 2013, this group completed nearly 6,700 industrial real estate transactions (excluding Capital Markets transactions) totaling 238.74 million square feet. The aggregate value of these transactions was greater than $7.34 billion. John C. Morris Executive Managing Director Industrial Services Lead for the Americas Tel: (847) 518-3218 john.morris@cushwake.com
Bethany Bailey Managing Director, Strategy & Operations Industrial Services, Americas Tel: (206) 521-0236 bethany.bailey@cushwake.com
CUSHMAN & WAKEFIELD INDUSTRIAL RESEARCH CONTACTS C&W’s Research Group provides a strategic advisory and supporting role to our clients. Through delivery of timely, accurate, high-quality research reports, we aim to assist our clients in making property decision that meet their objectives and enhance their competitive position. Maria T. Sicola Executive Managing Director, Research Americas Tel: (415) 773-3542 maria.sicola@cushwake.com
Tina Arambulo Managing Director, U.S. Industrial Research United States Tel: (310) 525-1918 tina.arambulo@cushwake.com
Jason Price Research Director – Tri State Suburbs New Jersey Tel: (201) 508-5208 jason.price@cushwake.com
Amanda Ortiz Research Manager - Chicago Chicago Tel: (847) 518-3235 amanda.ortiz@cushwake.com
James Breeze Research Director – Southern California Inland Empire Tel: (909) 942-4655 james.breeze@cushwake.com
Jared Jacobs Research Manager - Philadelphia Philadelphia Tel: (215) 063-4077 jared.jacobs@cushwake.com
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