The Cooling Distribution Center Market

A couple of months ago, I wrote about the cooling housing market, observing that just as in every prior rising interest rate environment, housing sales have fallen, and new home starts are contracting. This has been true at least 10 times throughout my 50-year career, especially during the Paul Volker and Alan Greenspan stewardships of the Federal Reserve, when both took strong steps to wring inflation out of our economy by sharply raising interest rates.

But rising interest rates do not necessarily have an impact on other segments of the construction economy, as projects typically continue to be announced and hotel, commercial office space, retail, and industrial buildings of all kinds expand their presence and footprints – despite the backdrop of rising interest rates.

Something Different. But something different is happening now – e-commerce-related distribution centers and other warehousing is facing a squeeze from a combination of a surge in construction and softening demand. The industrial real-estate business was already riding high from the explosive growth of online shopping when the COVID-19 pandemic caused nationwide lockdowns in 2020. That triggered a logistics building boom to meet the needs of retailers abruptly facing supply-chain bottlenecks and an increase in e-commerce activity after many bricks and mortar stores temporarily closed. 

As has been widely reported in the various business press outlets, logistics developers completed and opened a record 148.2 million sq. ft. of space in the third quarter, about 72% more than the quarterly average over the past five years. Now, this record amount of new warehouse supply is hitting the market just as mounting recession fears are slowing growth in demand.

And in a surprising development, bricks-and-mortar retail is having a resurgence. Despite the woes of some specialty chains like Bed Bath & Beyond, many new retail establishments are popping up nationwide as consumers tire of being stuck at home and want to go out and feel the goods they are buying while enjoying the satisfaction of filling a shopping basket. 

This unexpected turn of events in retail consumption has fueled widely circulated reports last spring that online retailer Inc. was throttling back on its e-commerce operations. Since then, Amazon has closed, delayed openings of and canceled plans for about 80 buildings in the United States.

Growth in Demand. Other figures show that the growth in demand for warehouse space is slowing across the board. Warehouse tenants occupied about 108 million sq. ft. more industrial space at the end of the third quarter than at its beginning, but that is down from previous quarters. They occupied 132 million sq. ft. more of new space in the second quarter, and 159 million sq. ft. more in the third quarter of 2021.

We all know the shift to remote work has been weighing on office values, while the reduction in business travel since the outbreak of COVID-19 has punished urban hotel owners. Both of those trends now seem to be shifting as office occupancies witness some return of previously remote employees, coupled with growth in business travel that has had a positive impact on hotel occupancies. 

But in contrast to the trend, some analysts say the need for new warehouses and rents will remain at a robust level next year, even if there is a recession. Many tenants are continuing to add logistics space to develop new supply chains and expand their e-commerce businesses which, as a rule, require three times more industrial space than bricks-and-mortar stores. 

Hit Hard. Yet as with most types of commercial real estate, industrial property values have been hard hit by higher interest rates. According to published research, while they were up 30% since the beginning of the pandemic, they have fallen 19% since they reached their peak in the first quarter of this year. Meanwhile, shares of industrial real-estate investment trusts are up 67% since the pandemic hit, but down 27% since this past spring when Amazon reported that it was reducing its rate of expansion.

So the future of distribution centers in the short term continues to be debated, but it nevertheless plays an important role in aggregates consumption. 

Pierre G. Villere serves as president and senior managing partner of Allen-Villere Partners, an investment banking firm with a national practice in the construction materials industry that specializes in mergers and acquisitions. He has a career spanning almost five decades, and volunteers his time to educate the industry as a regular columnist in publications and through presentations at numerous industry events. Contact Pierre via email at [email protected]. Follow him on Twitter @allenvillere.

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