By Rob O’Brian, CEcD, O’Brian & Associates
The U.S. economy overall appears to be gradually slowing down as the Federal Reserve interest rate hikes begin to have impact. Along with it, the warehousing and distribution sector also appears to be slowing down from its white-hot growth during and after the pandemic. But the slowdown is only to red-hot, as underlying factors such as e-commerce, manufacturing growth and on-shoring and near-shoring trends continue to drive the need for more warehousing and distribution space, especially in the traditional and growing hubs supporting that sector.
“Warehouse space growth is happening in all the top markets in the U.S. The old standby regions like Chicago, Dallas/Ft. Worth, Northern New Jersey/SE Pennsylvania, Chicago, Atlanta, Florida, Los Angeles, and the Inland Empire (CA) have grown the most in the past,” said Tim Feemster, CEO & Managing Principal, Foremost Quality Logistics in Dallas, Texas. Feemster noted there are a number of smaller regions that are now seeing growth in the sector including, but not limited to, Kansas City, Memphis, Nashville, Columbus, OH, Charleston, Greenville/ Spartanburg, Richmond, Las Vegas and Salt Lake City.
In many of these markets, the dynamics have been changing rapidly from the start of the pandemic in early 2020 through this year. Chris Gutierrez, President of Kansas City SmartPort, noted the regional warehousing and distribution market was strong prior to the pandemic, but came to an abrupt halt in early 2020 as the pandemic hit home. But the pause was short lived as demand rapidly increased for e-commerce space to serve people shopping from home. “We called it the race for space,” said Gutierrez. “We had companies that just wanted to get the space. They didn’t care about workforce or incentives; they just wanted to know the market and then get a lease.”
A Sector Slowdown Nationally
Despite the rush for space during the pandemic and for two years afterward, the sector is slowing down. This slowdown in construction of warehouse and distribution space was noted by Richard Branch, Chief Economist of the Dodge Construction Network in projections for 2023. Branch noted the warehouse space sector will see more “significant declines in commercial construction starts: during 2023. As reported in Construction Dive (1-9-23), Branch pointed out the warehouse and distribution sector is coming off a record year in 2022, where starts totaled around $57.1 billion, a 19 percent jump from 2021. But 2022 was the sector’s peak said Branch, pointing to Amazon, which announced pullbacks in warehouse starts in the summer of 2022. The e-commerce giant accounted for about 16 percent of all warehouse construction starts over the past three years, according to Dodge. With Amazon pulling back, Dodge forecasts warehouse construction starts to drop ten percent in 2023 to $51.3 billion. Despite the drop, 2023 will still be higher than 2021 and will still be a very robust year, according to Branch. “2018 and 2019 saw record levels of activity in the warehouse sector,” said Branch. “So, the one player stepping out of the market will see the levels come down, but overall, they should remain historically very high.”
The Dodge projections are also echoed by the latest nationwide data from Colliers. The absorption rate of industrial and warehouse space has slowed from last year according to the Colliers Q1 2023 Industrial Sector report. This report noted that first quarter absorption of space was 73.8 million square feet, a 37 percent drop from the first quarter of 2022. Vacancy rates in the first quarter were four percent compared to 3.8 percent in 2022. While that is a slight bump up in vacancy, the availability of space remains tight. Among major warehouse and distribution projects coming on-line in the first quarter of this year Colliers noted Walmart’s 2.2-million-square-foot facility in Indianapolis and competitor Target’s new 1.8-million-square-foot facility in Inland Empire, California.
The overall slowdown in warehousing and distribution is also reflected in the Logistics Managers Index. The Index is a joint project of the Council of Supply Chain Management Professionals and five universities (www.the-lmi.com). This metric is a composite of Inventory Costs, Warehousing Prices, and Transportation Prices. It ranges from 0-300 with any reading over 150.0 signaling expansion and a number under 150.0 signaling contraction.
The index peaked during 2021 and early 2022 as costs across all sectors skyrocketed but then began returning to lowering levels in the second half of 2022 and into this year. However, the May 2023 index is the lowest in the nearly seven-year history of the index and close to falling into a sign of market contraction, according to Feemster. “If this trend continues its downward trend, then it will negatively impact transportation companies, developers, and 3PL (third-party logistics) operators alike. They will all be squeezed for profits as volumes and the economy slow down” noted Feemster. He added, “As logistics prices come down and eventually moderate, we could see inflation continue to moderate, which may lead to a slowdown in interest rates and eventual recovery in the freight market.”
In the meantime, higher interest rates are impacting the development of speculative space, as investors consider the risk of financing large-scale spaces. Gutierrez said that one Kansas City region speculative space developer reported that he previously had around twenty investment partner opportunities but is now down to two. The Kansas City regional market is still hot, noted Gutierrez, but with little speculative space being built due to interest rates, most current projects are now build-to-suit. Nevertheless, projects are still happening said Gutierrez pointing to the recent announcement of a new, 1.5-million-square-foot distribution center by Ace Hardware.
Whether it is speculative space or a build to suit facility, another key driver in the slowdown of warehousing and distribution facility starts is a scarcity of site product. “The lack of immediately developable sites, served by all utilities including water, sewer, electricity, gas, high speed fiber internet and already properly zoned, especially ‘close’ to major markets is slowing down the site selection and construction process,” noted Feemster. He also pointed out there is even more scarce availability of ready sites in secondary and tertiary markets that could be considered as locations if they had product.
Another issue for the warehousing and distribution sector is the same one facing every sector, lack of available workforce. The Warehouse and Storage NAICS sector (493) saw employment growth of 50 percent from 2019 to 2022, adding more than 633,000 jobs, according to industry and occupation analytics and data service Lightcast. The rapid growth in the sector put pressure on employers to not only fill the new job openings but also replace employees who quit for other opportunities. Gutierrez noted that the Kansas City market employers in the sector made a number of changes in workplace culture as well as benefits and pay to attract and retain workers, but noted it was still difficult to fill jobs at the peak in 2022.
Tailwinds for Continued, if Slower, Growth
Despite the slowing in the warehouse and distribution sector as well as the overall supply chain components, there are tailwinds that continue to drive mid- and long-term growth in the market.
Although slowing down from the extraordinary jump in 2020, e-commerce continues to see strong growth. According to Statista Digital Marketing Insights, the growth in e-commerce revenue will be nearly fifty-five percent from this year to 2027, a jump of more than $560 billion. The continued growth in the e-commerce space will drive a need for more localized distribution space to facilitate next-day and the growing same-day delivery that many retailers are promoting. Along with goods, Gutierrez indicates he is seeing more third-party logistics operators responding to the growth in e-commerce, but particularly pointed out those building more cold storage for their own customers. “As we change the way we eat and order, there is more demand for cold storage,” Gutierrez added.
Another driver for the continued growth of warehousing and distribution is the move to re-shoring and near-shoring operations. Gutierrez noted he is seeing more focus on U.S. firms getting manufacturing and distribution back to the North American markets. But he is also seeing a number of foreign firms who are considering the U.S. in general and Kansas City competitively to shorten supply chains to the North American markets and lower their energy costs. Even companies that still rely on imported products and foreign suppliers are adding more warehouse space to better buffer their operations against supply chain disruptions. “It’s a move from ‘just in time’ to ‘just in case’; more centers, more backup in case supply chains get impacted,” said Gutierrez. He excepts that reshoring and near-shoring will continue, pointing out that his organization, KC SmartPort, manages the Foreign Trade Zone and that entity is seeing a lot of interest because of its positive impact on duties and tariffs, as companies continue look at ways to improve their supply chain operations.
While agreeing that there is a trend toward reshoring and near-shoring, Feemster notes it is a long-term process due to the complexity of supplier links in the production chain. “The U.S. spent more than 20 years executing the ‘follow the cheap labor’ offshore production strategy. It may take that long to reverse the process. The reason I say that is there are more links in the supply chain beyond the manufacturing site,” said Feemster. “For example, each auto plant has Tier 1 suppliers sending stuff, the Tier 1 has multiple Tier 2 suppliers, they have Tier 3 suppliers and maybe a Tier 4 or 5 as well. Almost all of these Tier 1 suppliers are manufacturing in Asia now and not in the U.S./Mexico/Canada region. That means they have to nearshore/onshore as well,” he added.
A major bright spot, according to the Dodge outlook for 2023 is in the push by both U.S. firms as well as foreign producers to build chi fabrication facilities and EV battery plants in this county. The $52 billion CHIPS Act and the $485 billion Inflation Reduction Act will support what it termed very high levels of activity in the coming years. Construction starts in the manufacturing sector reached $89.4 billion in 2022, a nearly 200 percent increase from 2021. Dodge expects that blistering pace to slow down in 2023 to about $51.2 billion, a 43 percent drop. While a large drop, that $51 billion level is a record for any year besides 2022 over the last three decades, according to Dodge. “I do think this is a real game changer in terms of stabilizing the construction sector in 2023,” said Branch, the chief economist at Dodge. “I would offer as well that I think that $51.2 billion is fairly conservative for next year. I wouldn’t be surprised if the upside here was closer to $60 billion.”
One of those electric vehicle (EV) battery facilities began construction in Desoto, KS, in the Kansas City region, in November of last year. Panasonic broke ground on the $4 billion dollar facility that is set to open in early 2025. “We were fortunate to get Panasonic,” said Gutierrez, adding that he anticipates the project will bring a number of suppliers and attendant warehouse operations. He also anticipates increased need for product recycling facilities and more raw material production in the North American market, creating more warehouse opportunities around the Panasonic plant as it ramps up.
Projected Growth and Shifts in the Warehouse Sector
While slowing down from the white-hot growth during and immediately after the pandemic, the warehousing and distribution sector is still adding employment for the foreseeable future.
According to Lightcast, the sector is anticipated to grow by more than thirteen percent from this year to 2031, adding more than 268,000 more jobs.
Warehousing and distribution operations are strongly driven by population. Consequently, the largest states for warehouse sector employment are typically the largest states by population.
The top dozen states for warehouse sector employment are generally the most populous states, with California and Texas at the top.
In terms of numbers of new jobs, those states will also be adding the most jobs until 2031. As a percentage growth rate, Lightcast projects all but one of the states (Pennsylvania) to meet or exceed the overall thirteen percent national growth rate.
All of these states are noted by Feemster as the traditional and continuing locations for warehousing and distribution. But he pointed out that warehousing and distribution are following the population trends. “Regional population shifts, driven by migration to new locations continues to benefit the Southeast and South-Central states,” said Feemster. While these are the strong areas now and the foreseeable future, Feemster said that California, New York and Illinois, will continue to be challenged as people move out. “Again, sector growth will be driven by the relative regional population over time,” Feemster stressed.
From his seat in the heartland of the U.S., Gutierrez says he is “seeing a lot of consolidation into the Midwest to reduce costs.” Gutierrez pointed out that west coast prices for space have risen substantially more than those in the Midwest. He is backed up by the Colliers Industrial sector first quarter 2023 report. In that report, warehouse and distribution space, on a triple net basis, is more than double the Midwest average pricing of $6.08 per sq. ft. The northeast is nearly double that of Midwest pricing.
The west coast facility prices are just part of a shift that is impacting imports and, consequently, the warehousing of those goods. Feemster notes that while the tremendous backlog of container ships waiting off of the coast during and immediately post pandemic has diminished, there is still uncertainty caused by contract negotiations with the longshoremen along with diminished imports from China. “The backlog has definitely improved in 2023, but lower import volumes are expected through the first half of 2023 as noted in Port Tracker. This has caused retailers to reroute shipments away from the West Coast ports to the Gulf and East Coast ports,” noted Feemster. He also pointed out this shift may be permanent based on what happened during longshoreman contract negotiations. “In 2002, the Ports locked out the union and that started the movement from a 60/40 West/East Coast volume split to the 50/50 split that exists today,” Feemster added.
Among the challenges for the warehousing and distribution sector noted above, is the difficulty finding and retaining workforce. While employment in the sector is expected to grow, companies are turning to more automation and technology to meet their needs for efficiency. Substantial growth in warehouse automation, both hardware and software, anticipated, according to Allied Market Research. AMR projects the market will grow from $13.6 billion in 2021 to $57.6 billion in 2031; a Compound Annual Growth Rate of more than fifteen percent.
The automation of warehouse and distribution operations is definitely needed according to Feemster. “The pandemic exposed many gaps in companies’ global networks. You heard in the news that firms did not know where their items were in the supply chain incoming from factories. They did not know if the items were produced and shipped from the factory or not. Even if they were shipped, they did not have the capability to determine where they were. That is why many companies have been taking advantage of new technology in their firms,” said Feemster. He pointed out that automation and the introduction of AI can make an impact on the productivity of facilities, domestic transportation mode selection, and global trade. “Robotics are in every advanced company facility. Those without them in large operations are falling behind in productivity and cost savings. These robots are not replacing workers, they are substituting for workers who the company can’t hire,” Feemster added.
Attracting Warehouse & Distribution Operations to Your Community
As the sector continues to growth and shift, there are opportunities for both the “traditional” centers and new players to attract warehouse and distribution companies. But it takes work and focus, starting with understanding if your community is a good fit, noted Feemster. He points out that every organization has to understand which industry clusters are the strongest in their area currently as well as understanding what, in particular, the warehousing and distribution sector needs to determine the match against existing or possible assets. As Feemster noted above, population shifts will create opportunities for the near big metro areas as well as second and third tier communities. But he stressed communities need to really be prepared with “ready sites with all infrastructure, a depth of workforce and skills training from local educational institutions to enhance the skills of the incoming workforce from the community,” Feemster added, “If your community does not have ready sites, as discussed before, along with the educational community working with the local business community to prepare new workers and up-train existing workers for advancement, then they will lag behind in growth compared to the communities that do execute these priorities.”
Gutierrez strongly noted that the Kansas City region has been united under the KCADC umbrella, of which KC SmartPort is a part, for more than three decades. This regional effort has allowed for seamless presentation to and handling of prospects to strengthen opportunities for all partners, across the spectrum of projects. Specific to warehousing and distribution, Gutierrez pointed out it has been a fifteen-year effort seek, support, and attract companies in this sector. “For us it’s the Four L’s: Location, Labor, Logistics infrastructure and Love,” said Gutierrez. He noted that not every location fits a company’s needs, but when it does then the infrastructure and labor become important. And then there is the “love” supporting a new or on-going operation. Permitting, incentives, work on training all have helped, he added.
Agreeing with Feemster on the needs for ready sites, Gutierrez noted for warehouse and distribution companies, as with most, it is about speed to market. “The more steps to show a company that you are vertical ready, getting a building going up, the better it is,” said Gutierrez. “Having utilities on site, ready to go is very important. If you can get a spec building of some sort going it will help,” he added. Gutierrez pointed out that there is a lot of federal funding in various program right now that can help communities and counties get their utilities at capacity and at site.
Incentives like free land don’t get attention anymore. “You have to have a site that’s ready to go. Just offering free land is not an incentive at all,” Gutierrez added.
That sentiment was echoed by Feemster who pointed out that even certified and/or shovel-ready sites are often not ready because they don’t have utilities at the site or close enough to be extended in a timeframe the company is seeking. “Land without ALL the utilities and zoning is just land, not a site,” said Feemster.
Whether it is warehousing and distribution or some other sector, both Gutierrez and Feemster point out the economic development organizations need to start the “love” at home. “Communities, regions, and states need to concentrate on business retention and expansion. This is the bread and butter of economic development; keeping their existing companies growing and getting talented workers,” said Feemster.