What a difference a few years can make.
Thinking back to 2019, it’s easy to recall that the distribution market was generally in great shape. Balance sheets were in balance. Capital was available and expected to become more so by C-suite executives, and accounts were liquid.
Then came COVID-19.
And suddenly, the process of receiving and sending shipments became much more complicated for myriad reasons. Some companies that had overseas setups under favorable financial terms suddenly couldn’t ship or receive product; those that did often lacked adequate space in the domestic locations ― if they even had enough domestic locations. Then adding the shortage of workforce and truck drivers to the equation equaled a sorry sum.
That meant it was time for action that resulted in more easily accessible product being built very quickly, sometimes even on spec, to satisfy a suddenly insatiable demand. And that worked. For a while.
But today, many of those spaces are too big for many companies that expanded and subletting has become common. So the market has shifted somewhat in the eyes of observers like Owen Rouse, senior vice president, brokerage, for Baltimore-based MacKenzie Commercial Real Estate Services.
“I think there has been a slowdown in the development pipeline for distribution space that would be delivered on a speculative basis, versus a build-to-suit project for a given tenant,” said Rouse.
Market Shift
That’s not to say that spec projects have disappeared from the current market, however.
“Spec is still a good option at times because you want to build into the demand side of a market,” Rouse said, “and be ready when a requirement arises; you build some portion of spec to carry into your mass.”
But that also means budgeting properly for spec. “And remember that building owners budget for that when they do it,” he said, “and you’re not marketing the building when it’s finished. That starts when ground is broken.”
As for what’s happening across the general distribution spectrum, Rouse cited its three main sectors: retail fulfillment, ecommerce and wholesale distribution, and how those sectors can intersect.
“For example,” he said, “a retailer like Target or Sephora may utilize one facility for retail store fulfillment, whereas smaller facilities service multiple outlets and retain another facility for e-commerce. But some retailers may choose to combine the functions under one roof for other reasons, such as the size of shipments and order composition.”
Larger footprint e-commerce “will likely have a broader distribution pattern and need to be strategic from a logistics standpoint,” said Rouse.
Third comes the wholesale distribution that might be utilized by a company that manufactures and/or sells inventory that is generally not accessed by the public (think HVAC, plumbing and auto parts) with a more warehouse-to-warehouse model. “Such distributors may be invisible to the public, but are an integral part of the U.S. supply chain,” he said.
While much attention was given to distribution during the pandemic, which Rouse feels did indeed “change some distribution patterns to make warehouses more accessible by bringing on shoring to the fore,” he also said that it “might not have changed it forever.”
“There could be a return to long-mileage shipping, but you may also balance that with on shoring in case of the next worldwide event. I think companies will reassess that approach more in the future, which will lead to distribution becoming more dynamic,” he said. “Will companies need more or less, bigger or smaller, close or not?”
Rouse also pointed out that there are, and will always be, mergers and acquisitions. “If merged companies have overlapping facilities in a specific city or geographic region, a decision will need to be made which to keep.”
It may be that a merger partner has a significant presence in a logistics-heavy market, “which would play into the discussion of a shift in distribution practices,” he said, while also observing that a footprint in Memphis, for instance, includes access to the Mississippi River and the Port of Memphis, 30 truck lines and overnight connections to an estimated 85 percent of the country, FedEx headquarters, and the Burlington Northern and Santa Fe railroads, according to the Greater Memphis Chamber.
“Or they may not need Memphis,” said Rouse, “because they suddenly have three other distribution locations in mid-south.”
Such scenarios fall under the heading of a larger logistics conversation that also has to do with an expansive radar screen that encompasses trucking, software, infrastructure, transportation, union (or non-union) labor, etc. “Think of distribution of not just the building,” he said, “but this broader conversation in which physical space is just part of the conversation.”
And part of the answer now involves the artificial intelligence factor. “All this can happen in real-time due to the advance of AI’s integration into software,” Rouse said, “ultimately producing a more anticipatory response.”
New Workforce
Among the preferred locations for distribution hubs are often those with multi-modal transportation options ― such as, as Rouse noted, Memphis. That’s the home of Paradigm Realty Advisors, where Principal Tracy Speake offered his observations on the market.
“I see two major trends,” said Speake, “One is that the higher interest rates during the past couple of years have deterred development. During COVID-19, companies rushed out and leased space resulting in more than 15 million of square feet of net absorption of industrial space in our market in 2021. Subsequently, we saw 14-plus million square feet of new development to handle the substantial increase in demand in 2022.”
In a market “where five million square feet of new absorption was considered robust, these staggering developments and net absorption figures were just unfathomable in Memphis’s history,” he said. “The feeding frenzy that occurred in every major distribution market as the nation was quarantined was mind-boggling.”
Now, however, Speake pointed to “a correction in the market, as companies validate their true space needs post-COVID-19,” he said, “and we’re seeing more and more starting to sublease space along with a substantial reduction in demand.”
And that, said Speake, is foreshadowing falling rental rates as real vacancy rates rise,” he said, “unless we get a hoped-for spike in demand.”
The other major trend is the relation between the size of the warehouses and the sophistication of the workforce required to run them.
“Back in the early ’90s, a company might have leased a 320,000-square-foot bulk warehouse and needed 100 employees,” said Speake. “Now, 400,000 square feet may only need 25 to 30 workers.” As warehouses grow taller and logistics become more revolutionary, the pool of labor that can run these warehouses during full employment is in short supply and critical to the project’s success.
“I think that trend will continue,” he said, “especially with major companies utilizing robotics and strategically focusing on warehouse automation.”
What has occurred during the past three decades is that as warehouse processes have advanced, the demand for sophisticated workers has also increased. “It’s not just about forklift operators anymore,” Speake said, “and we’re seeing this across the board. And that’s where you’re seeing capital investment to offset labor costs, especially since all other costs are high. There’s only so much inflation that the consumer can withstand.”
He added that, despite the progress, labor costs and availability are now major factors for companies when seeking new project locations.
“When you get down to 5% unemployment around the country, especially in certain markets that lack the education level of others, you’re basically at full employment. “So that’s why,” Speake said, “we’re seeing more companies focus on autonomous operations. It helps to address and deal with the labor shortage and increases in labor costs.”
Parts, Supplies
Also noting the shifts in the market, but with other twists, was Chris Lloyd, senior vice president/director, infrastructure and economic development for McGuireWoods Consulting, Richmond, Va.
Activity and leasing “is slower than it was during the COVID-19 era, when it seemed like there were projects going on all over the place,” said Lloyd, who recalled that “it was to the point that new properties were often leased before ground was broken.”
But Lloyd’s more recent observations come from another direction.
“If you’d asked me six months ago, I would have said [the distribution market] was nearly dead. During 2020-2022, developers and end users added record amounts of new warehouse capacity, particularly to address consumer demand with brick-and-mortar stores closed and consumers moving online,” he said, “but as the world returned to normal, the warehouse market got overbuilt.
“Today,” said Lloyd, “there’s some subleasing with that overcapacity in certain markets, which is still being absorbed.”
The reason the subleasing or renewed construction hasn’t been as swift has to do with some of the aforementioned changes in the market since the end of the pandemic.
“The rise of interest rates and construction costs due to inflation has also affected that part of the market,” said Lloyd. “There also remain several supply chain constraints impacting delivery of new product. For example, companies are having a hard time getting circuit breakers and transformers for these facilities. Today, we also hear that rooftop HVAC units are in short supply. As a result, new product is coming online more slowly.”
While the overall supply chain issues of recent years are “much improved, with steel and concrete again easily available,” he said there are still issues in obtaining other parts of a project, like those HVAC units.
“The factories which make these vital components are still backlogged and are also seeing new demand driven by federal policies, like the Inflation Reduction Act, and continued on shoring,” said Lloyd, “because they’re not just used for distribution. They’re used for all sorts of industries and there aren’t enough to go around.”
Then comes the public pushback that germinates from the fact that buildable sites and land are harder to pinpoint. “Some communities have said that they’re not going to allow any more such projects of a certain size,” said Lloyd, “sometimes including last-mile facilities near larger population centers that are typically smaller than the big warehouses. People don’t want the traffic and the trucks that come with such projects.”
When land is available, there is a growing sector of the populace that thinks it should be used for projects that create more jobs, such as clean energy and electric vehicle projects, or used for data centers “that generate strong tax revenues without the traffic,” he said. “These are policy choices developers are having to take into consideration when determining how best to position their land holdings.”
Cost of CRE
A similar tune was sung by Grayson Scott, senior client consultant for CBRE Supply Chain Advisory, Houston. “I think with the pandemic, there was a rush for space, with the right inventory, the right product and the right amount available,” he said, and “The reaction to that market pushed development.”
But then a funny thing happened on the way to the warehouse.
“As circumstances have evolved, many organizations are finding that they don’t need as much space as they leased,” said Scott. “Or they may not need to have 1 million square feet at one facility because it might make more sense to operate five smaller warehouses in certain regions of the country.”
While much attention is paid to the size of leases, much of the cost of operating them comes from other areas. “Much of the cost to the company that leased the building is not as much the commercial real estate, but transportation,” he said. “That’s followed by labor, inventory and administration costs.”
“So logistics are a large amount of the bottom line,” said Scott, “and the costs vary, but commercial real estate is only about three to ten percent of the total cost of the entire distribution operation. We tell clients to look at their needs holistically when considering strategy and growth; the size of the lease is often a consequence of those decisions.”
So what’s ahead? Scott thinks the market “will still see many organizations exploring near shoring, given supply chain considerations as companies work to optimize their operations. I think they’ll realize the benefits and reliability of accessing products in a more reliable and cost-effective manner. So I think that investment will continue.”
And like Lloyd, he’s not surprised regarding the HVAC problem.
“Just a couple of weeks ago, we were working with a new client and the lead times to get products to a final destination were still varied on an ongoing basis. That issue has evolved a little bit,” he said, “but some companies (are still struggling to acquire) materials due to disruptions within the distribution industry, such as the Panama Canal depth issue, the Baltimore Key Bridge collapse, hurricanes and other weather issues.”
And he also agreed that the Not-In-My-BackYard (or NIMBY) policies are coming more to the fore, depending on the community and its zoning laws, which are “often not friendly for industrial development,” said Scott. “Overall, the locations have found that they feel there are better options such as data centers, life sciences projects, advanced manufacturing facilities,” etc., that may be more complimentary to the community development efforts.”
And again, those rising interest rates “have caused considerable pause across the industry,” he said, “with more due diligence and delayed capital expenditure decisions with our clients, some who are still looking to move forward, anyway.”
However, Scott found a silver lining herein. It concerns need.
“Even if it’s more expensive to build or lease a large project now,” said Scott, “it may still make financial sense.”
Job Impact
Like Speake, Matt Ryder, principal at Avison Young, in Atlanta, addressed the investment of automation and robotics in the current market.
“One of the more intriguing trends in supply chain strategy is the increasing investment in automation and robotics,” said Ryder. “Many of my clients are exploring technologies that could drastically transform manufacturing and distribution center operations. For example, these technologies could reduce the workforce in large distribution centers by 75 percent or more, significantly impacting operational planning.”
And without the need for so many workers, where will these highly automated operations be located could be changing.
“Without the need for large population centers to supply labor, the location criteria will change,” said Ryder. “The skills requirements for workers in these operations will be much greater, shifting from moving products around the facility to maintaining sophisticated equipment.”
“How will workers be trained for these more technical roles? Moreover, will states and local communities use economic development incentives to attract these operations?” he queried.
Historically and currently, there is an emphasis on using incentives primarily for job creation, Ryder said. But he wonders if economic developers will “become excited about projects that, despite having a significant fiscal impact (e.g., creating incremental property tax revenue), don’t create many jobs.” As companies contemplate the size of these more automated operations, will they find it easier to achieve economies of scale with fewer, larger operations?
“This could lead to centralization of the supply chain,” said Ryder. “With labor costs potentially becoming less of an economic driver, will more of these operations, particularly manufacturing, be located in higher-cost labor markets? If so, with the trend toward near shoring manufacturing and the potential for increased tariffs on imported goods, we could see a rise in domestic production.
“Overall,” he said, “the rise of automation could have profound and fascinating impacts on supply chain strategy.”
One at a Time
Those thoughts are shared, no doubt, by Jay Strother, president and CEO with the International Warehouse Logistics Association, in Des Plaines, Ill., which represents about 420 warehousing companies (and about 1,400 warehouses) across North America. Strother has noticed a couple of main trends from the perspective of his organization, which operates in the third-party warehouse space.
“Our members move product that is not their own,” with the range of what’s moved limited only by one’s imagination. “The products could be for light or heavy industrial use,” said Strother. “It could be baby formula or crude oil, or work clothing or chocolate.”
From the standpoint of the IWLA, “Warehousing is not just about moving pallets anymore. Warehouses have added value since then because they’ve built upward in more recent years and can handle larger inventories, now with new technologies used to access product,” he said.
How refined has the approach become? “They can break down a pallet, move just one product that’s needed,” Strother said, “and ship it right to the consumer.”
It’s crossing industries and entering manufacturing, too.
“One of our members fulfills blank T-shirts and takes orders directly from a company’s consumers, then presses the decal themselves ― so the company it was purchased from never touches it,” he said. “That saves money for the company and the consumer, and speeds up the supply chain.”
While that overall market “has slowed because it mirrors the economy, with inventories down by 12-15 percent at our member’s warehouses in recent quarters,” he said, “things are starting to pick back up as inflation has started to drop.”
“Inflation is still high, but there are so many pressures on the consumer in today’s volatile market including wars, political infighting, weather disasters,” etc., “that we feel that warehouses have been the calm during the storms of recent years,” said Strother.
“We’ve also seen many retailers and manufacturers realize the benefits of the third-party approach, especially during COVID-19, when the online ordering trend spiked. People wanted their merchandise when they were stuck at home and there was a lack of space to store it,” said Strother. That called for “an adjustment as our members acted as clearinghouses for companies that were searching for temporary places to store product.”
Imagine companies that sell candy, for instance. “They needed third-party locations with a company that is experienced in that market,” he said, “and knows the inner workings of the USDA, FDA and similar organizations.”
Help Still Wanted
Another key trend Strother also discussed is that many IWLA members are at the forefront of technological advances in tracking inventory.
“They also use drones, AI, predictive analytics,” etc., he said. “The economy has become about the inside of the warehouse and how that space can be maximized, physically and financially. Now things that sell fast are more easily accessed up front, and whatever doesn’t goes in the back.”
While Strother feels that “People seem to be scared of AI, [but] in our world it boosts inventory management efforts with calculated predictions on what will move first, thus saving time and money.”
And while fewer employees are needed to operate these gargantuan structures than there were two decades ago, “it’s been hard to find people to fill those spots anyway since this isn’t the sexiest industry,” he said. “That’s why we [employ] new hiring strategies, like recruiting from second chance programs, for instance.”
So while it may not be “the sexiest” industry, distribution is certainly crucial. “Warehousing is the backbone of the economy,” Strother said, “and we found that out during the pandemic. We did a great deal of work to ensure that distribution workers were seen as essential workers.”
Odenton, Maryland-based Mark R. Smith joined Expansion Solutions after having written about site selection among the vast number of topics he has covered in the 
business universe. That part of his career began in 1993 when he joined The Daily Record, a Baltimore business and legal publication, where he delved into the worlds of economic development and commercial real estate, among numerous other industries; in 2003, he was named editor-in-chief of The Business Monthly, another Maryland publication that covers the scene in the Baltimore-Washington Corridor counties.
