Newmark’s Lisa DeNight On the Coming End of Industrial’s Hot Streak

Yes, the industrial warehouse market is probably the one most suited to these pandemic-pushed times, which have consumers staying home and ordering items on their phones or tablets, and, compared to the retail, office and hotel markets, it’s the place to be for investors. But it’s not totally insatiable. Nor is it immune to the negative impact of inflation, or to supply-chain bottlenecks.

Just recently, Amazon (AMZN), the giant of giants in e-commerce and singly responsible for the repurposing of hundreds of square miles of obsolete factory space for distribution use, announced that even it had more fulfillment space than it could use and was putting some 10 million square feet on the sublease market.

Lisa DeNight, national industrial research director for Newmark (NMRK), keeps track of the surprisingly nuanced market for the global commercial property brokerage and its clients. She authored a recent report that spelled out some of the challenges facing both landlords and space users.

The Philadelphia-based DeNight jumped on Google Meet earlier in July to explain some things to Commercial Observer. Her remarks have been edited for length and clarity.

Commercial Observer: Why is there a construction shortage of industrial space?

What there is is a delivery shortage. There’s no shortage of construction projects in the pipeline. But there is a delivery shortage relating to the supply chain issues, unforeseen constraints, and then there is the additional pressures of high inflation and interest rates. With all of this combined, we are seeing the timely delivery of warehouses and other industrial projects taking longer than ever.

One of the things the report says is it takes five months longer to get a project approved and built than it did in 2019. Why is that?

If you break the process out into pieces, there’s the entitlement side, and then there’s the active construction process. And both of these parts are taking around two and a half months longer than in 2019. There’s an incredibly high demand for projects, and the local governments either have not rehired the staff they lost during the pandemic, or they have the same staff and are dealing with an immense increase in demand. So there’s a labor issue in terms of getting entitlements.

Then, from when the building actually breaks ground, to the moment it’s completed, there’s a whole slew of challenges there, too, like labor, actually getting the people to build the facility. But, before any of that takes place, there’s the sourcing of materials and the length of time it takes to get anything. You have to order now for something you want to build a year from now. It’s a really challenging environment from a sourcing and supply chain perspective.

Your numbers show it’s rather uneven. In Los Angeles, entitlement time has grown from 13.5 months to 19 months. In the Inland Empire, it’s a little bit less, but it’s similar. Yet in New Jersey, it’s the same 12 months. Why the discrepancy?

These averages are a range. The range is vast for each of those markets. I underline that strongly. It was really amazing to talk to developers and to talk to construction companies and brokers and learn what it is like in an individual market. You take Dallas-Fort Worth, for example; there are 30-plus cities in that metro region, and each municipality can have their own diverging timeline for entitlements based on the local staffing levels.

I was talking to a developer who said he built a building in one municipality that didn’t even require a permit. And then you go to Fort Worth and, in your best-case scenario, you’re looking at a 12-month entitlement period. It’s kind of difficult to pin down a single number for an entire metro.

What is happening in Chicago? That was one case you cited where it was relatively easy to build. But it’s now turning challenging.

Chicago and other cold-weather markets have this issue where warehouses are built with a type of material referred to as precast [concrete]. A pre-cast block needs to be poured and then transported to the construction site. And this is a function of weather-related installation needs. It’s also tied to union labor standards for building material. And Chicago has a handful of local precast manufacturers who are dealing with extraordinarily constrained labor pools.

That is almost exclusively why the Chicago market is so strapped. Eighty percent is not an exaggeration in terms of how much longer it’s taking a warehouse in Chicago to be built compared to the Inland Empire and different markets.

How has inflation increased costs for developers? And is it still profitable to build?

Absolutely, yes. Inflation has made everything in the construction process cost more. And with a sub-4 percent vacancy rate, there’s still a leverage for rent growth at least through this year and probably into 2023; and at a pretty good pace, maybe not at the same height that we saw over the past few quarters. But inflation for developers that are still moving forward on projects, to make a project pencil out, the rents have to be more expensive.

On the flip side, there are some developers who have paused on new developments because of inflationary pressures and concern about where the market may go over the next 12 to 24 months. The issue that goes hand in hand with inflation here is the higher interest rates that make the cost of capital more expensive too.

And because there has been a good amount of volatility in market prices because of interest rate hikes, that has also added some additional time on projects.

One of the things I wanted to ask you about was Amazon. Amazon was by far the largest user of warehouse space across the country, and then very recently it announced that it would cut back. And I think that created a sense that it wasn’t an insatiable market. What impact are you seeing?

A lot of companies are not gobbling up space anymore. It’s more about how can you optimize your supply chain? How can you optimize your footprint?

That, I would say, is the influence, perhaps, of Amazon’s decision. It’s not that every other company, or even most companies, are suffering from too much space — in fact, quite the opposite. There are many companies that still, in the past two years, have not been able to secure space because the larger companies have taken space off the market. There’s still pent-up demand.

But I do think the overall sentiment is “we’re not going to gobble up space, anywhere we can find it, as fast as we can find it. We’re going to think more critically about how to optimize our supply chain going forward.”             

So users are, excuse the expression, looking for more bang for the buck, rather than just taking space and having it in hand.

Exactly.

You cite a 120 percent growth in demand from 2019 to 2022. What’s driving that?

That is just a tremendous thing, and what was driving it really was the incredible shift in consumer spending habits we witnessed over the pandemic. If everyone is confined to their house and ordering online, you’re going to need an Amazon warehouse or an e-commerce warehouse to service that customer.

The e-commerce story is very much a part of what’s driving this. But the other side of the equation, and certainly this is well-documented, is the tremendous influx of cash into the average consumer’s hands. It wasn’t just “I’m going to purchase my products online, but I’m going to purchase a lot more products.”

It was very heavy on the home improvement side. If you’re stuck in your house and want to improve your house, maybe you get new furniture, maybe you get a hot tub.

So what is now causing some developers to pause their projects, and maybe sell their development sites?

There is inevitably going to be a deceleration in industrial demand. You had over 500 million square feet of absorption in 2021. That is not sustainable.

That was a once-in-a-lifetime conflation of unique factors. So, we expect industrial demand to moderate to what we saw pre-pandemic. Still a strong market, but in relation to what we have seen in the past two years, it will be a deceleration.

If you look at the construction pipeline, which is at an all-time high, nearly 600 million square feet nationwide, I think a number of developers have taken the temperature of what’s going to happen in the next 12 to 24 months, including tenant demand the volatility in pricing, which is not transitory.

There are some markets where you literally cannot overbuild —like the SoCal market, northern New Jersey — where there are so many barriers to entry, and there’s little land on which to build, and persistently high tenant demand because of the proximity of the port and population centers. But in other parts of the country, where these factors don’t come into play, and perhaps things look less desirable against the fundamentals, that is where the question comes up of should there be a pause.