This ‘Bad News, Good News’ Story is Far From Over

Supply chain disruptions have had a direct impact on CRE—not only in port cities, but in any market that relies heavily on warehouses; space has become scarce and rental rates have spiked. In response, expert brokers have had to become more creative and more assertive—and they are advising clients to do the same.

“We’ve seen the single biggest impact as just a further delay in the process of supply creation, and particularly on the industrial side of the market right now that lack of supplies is what is driving really, really strong rental rate growth,” says Gabriel Silverstein, SIOR, managing director, SVN | Angelic, Austin, Texas.

There is a lot of money available for construction and high interest in creating new supply, he says, but there are also two things holding it back: municipalities are possibly moving more slowly than ever, and, of course, the supply chain.

“When somebody tells you that you will have a 56-week [wait] for roof trusses and an industrial facility usually builds in 40 weeks, that’s a pretty big material change,” says Silverstein. “It not only delays the completion of some of that new supply, but it also drives up the cost basis—not just because materials are higher and in demand, but also because of carrying costs. With an extra four months there’s a significant cost in interest, land; that’s real money.”

“It has created significantly more demand for both warehousing space and yard space for storage of trailers, containers and chassis,” adds Christopher Sheehan, SIOR, senior executive vice president at Colliers in El Segundo, Calif. “Clients are complaining about getting the inventory they need to make their product and/or to sell their product. Lack of labor is also negatively impacting our clients’ ability to provide their goods and services.”

Of course, ports are bearing a huge brunt of the burden. “The supply chain issues and increased demand for warehousing have placed tremendous pressure on our industrial availability, with a current vacancy rate of 0.6% and some of the highest lease rates in North America,” reports Baktash Kasraei, SIOR, vice president with JLL in Vancouver, Britsh Columbia, the largest port in Canada. “Occupiers are seeing 200% rental increases from five years ago.”

And Anthony Bergeman, SIOR, executive vice president/principal, DAUM Commercial Real Estate Services, Gardena, Calif., who works the Los Angeles ports and Long Beach logistics markets, is seeing a similar picture. “Vacancies have always been historically low,” he says. “Now it’s just magnified because everything has jumped up so quickly.”

He says he’s seeing a vacancy rate of less than 1% vacancy, with 45% “bumps” as pretty standard in rent escalations, and the rare new developments are pre-leased during construction—“even out to the Inland Empire.” Bidding wars are common, he adds, with tenants willing to pay more for space near the ports.

There’s also a premium for functional space, which is lacking in the market. “There’s only a finite amount, and that will be the market for the foreseeable future,” he says.

ADDRESSING THE ISSUES

One of the frustrations facing CRE pros, notes Bergeman, is that there’s nothing they can do to change the market; it is fully in-filled and fully built out, and new product can’t be created. He tells tenants they have to start looking as early as possible and pay what the market is at that time. “I’ve seen leases inked, and by the time they move in it’s already under market,” he notes. Ideally, a tenant will have an option, “So exercise it,” he advises. If they don’t, “they should engage as soon as they can—a year out, 18 months, however long the landlord lets them.”

Sheehan takes a similar approach. “When we are representing tenants, we tell them that they need to move very quickly because if they are slow in responding in negotiations, it is likely that they will miss the deal because someone else will take it,” he says.

Landlords, Sheehan adds, require different advice depending on their business plan and motivations. “If they are very aggressive, we will advise them to move slowly to create more bidders and hopefully bid up the lease rate,” he shares. “If they are more occupancy-oriented and not trying to make every last penny, we will pick the most qualified prospective tenant and try to engage them in exclusive negotiations.”

The bottom line, he says, is that “We are trying to get creative in finding the needed space and moving quickly so we provide all the current options available in the market in a timely manner—so we can put our clients in the best position to win a deal. We’re also being more aggressive in communicating with the larger landlords in the market, so we can find out about pending availabilities before they hit the market.”

Kasraie says he spends more time educating clients about the current conditions. “Site selection has shifted from evaluating many options to finding one or two off-market options and executing quickly,” he says.

He adds that he is actively engaging clients much earlier in the lease cycle—24 months or more in advance—to proactively forecast needs and engage landlords and developers. He advises clients to “be flexible and act decisively. For buyers and tenants, gone are the days of lengthy RFPs and long due diligence periods.”

Kasraie notes he is also much more involved in the development cycle, from land acquisition to pre-construction leasing.

“We challenge people to look at new suppliers; that includes even new vendors who might be able to look for new suppliers,” says Silverstein. “In a project we’re looking at now in Austin, they have introduced a new general contractor to the developer they previously didn’t know. That contractor is in the process of doing a building in Dallas for Prologis; they have some credibility, and in that deal, they’ve been able to start putting up roof trusses in a matter of only 20 weeks because they found a factory that would make them.”

Silverstein says he personally visited the factory in Mexico. “When the first shipment came to Dallas, just to be sure of the quality, they physically X-rayed them, and Prologis was thrilled,” he reports. “This was a small- to mid-sized contractor people would not necessarily have known. Now we can potentially do the same thing on a project in place already.”

Silverstein says he met the company through industry connections and struck up a dialogue. “On the surface, I had no need at the time for them, but all of a sudden we continued to have conversations, I really liked them, and they’ve been really helpful introducing me to other people.” This all began, he relates, through his contacts with other SIORs. “That network of people that many of us try to maintain, and built over the years, has suddenly become really important.”

NO RELIEF IN SIGHT?

Despite well-publicized efforts by the federal government to smooth the flow of goods, there is little optimism among SIORs that things will improve—at least in the short-term. “I’m pretty sure you can’t use ‘improvement’ and ‘government’ in the same sentence,” says Silverstein. “There are many supply chain problems we have by the government—travel restrictions, trade restrictions, and restrictions on employees and employers.” Pent-up demand due to COVID-19, he adds, “did not cause the problem; it highlights it.”

Bergeman also fails to see improvement. “The main thing is we can’t get enough chassis; we have more hours (for the ports to be open), but also a lack of drivers. We have these multiple negative factors.”

He sees the problem as one of longer term, with a market under-supplied with modern product. “Until it’s all fully redeveloped, it’s not going to get better anytime soon,” he declares.

Unlike these other ports, the Port of Vancouver already operates 24 hours a day, so no government intervention has been necessary, says Kasraei. As for how long the supply chain problem will last, he sees a mixed picture.

“There is a short- to medium-term component due to pent-up demand and supply chain issues, which will be addressed in the coming 12-24 months, but there are also systematic changes from a leap forward in e-commerce adoption to levels that were not expected until 2023-2024. Developers have not had the time or the land supply to respond to [this leap] with an increase in the supply of logistics buildings,” he shares. “International trade tensions have also harmed just-in-time logistics, leading to inefficiencies that require higher inventory levels and reshoring of some manufacturing capacity.”

Has Sheehan seen improvement following government actions? “Not really,” he states. “Just by opening ports on a 24/7 basis doesn’t directly translate to alleviating supply chain congestion. You have to have drivers to move the product and open warehouses with warehouse workers to move and store the product. Most warehouses aren’t open and staffed at 2 a.m. in the morning.”

He is a little more sanguine than his fellow SIORs on the prospects of the supply chain situation improving. “The current situation was definitely exacerbated by COVID-19 demand and changes in shopping habits, but I don’t expect this to be the norm going forward,” Sheehan says. “Workers will come back to work in factories and warehouses across the globe, and we’re already seeing the cost of shipping containers across the ocean come off their historic highs. Will we get back to where we were before the pandemic? Probably not, but it won’t be as bad as it is right now.”

MAKING ADJUSTMENTS

Based on their judgment that things may not change for a while, brokers have been adjusting their business approaches. For example, says Kasraei, “We are working on expanding our reach to markets three to four hours further out, as well as working with developers to intensify core industrial sites to meet the rising demand.”

Of course, it’s not all bad. Sheehan notes that controlling listings is definitely a lot easier at this time than working with tenants, “but the pendulum always swings; we just don’t know when.” The greatest opportunity right now, he says, is selling quality industrial real estate, “because there are so many new buyers out there competing with the traditional buyers.”

For the medium and long term, he continues, the focus will be on maintaining and growing existing landlord and tenant relationships, and using his company’s market knowledge to advise them concerning their particular situations. “This run can’t go on forever, but there sure don’t seem to be any near-term roadblocks!” he asserts.

“You need to start exploring a lot of different things you did not think about exploring in the past, like using different contractors, suppliers, and places to get stuff,” adds Silverstein. “From both a user’s point of view and a developer-owner’s, strategically, when you get into supply shock problems, it’s important to try and step back and start asking questions; how can we maybe get by without having to do what we were going to do for two years, until that problem gets resolved—especially when you cannot control its resolution?”

You can find a lot of interesting solutions, he continues, when you challenge things through basic “What-if” questions. “We can’t get a new building; can we change operations? Functionality? Think about all of the buildings being inspected using drones. The technology was there already, but it was not used. Now, with restricted employment, and ‘essential workers,’ it accelerated the adoption of that tech solution—and guess what? It’s actually better.”

Those are the situations, says Silverstein, that can create innovation. “Necessity is the mother of invention, and this is necessity ,” he says. “Find a solution you may never have thought you could get to, and those solutions may even be better.”

This article was sponsored by the SIOR Foundation - Promoting and sponsoring initiatives that educate, enhance, and expand the commercial real estate community. The SIOR Foundation is a 501(c)(3) not-forprofit organization. All contributions are tax deductible to the extent of the law.

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CONTRIBUTING MEMBERS

Anthony Bergeman, SIOR

Baktash Kasraei, SIOR

Christopher Sheehan, SIOR

Gabriel Silverstein, SIOR