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Big Money in the Big Box

The process of competition pushes firms to experiment with new business models as they seek any edge that will cut expenses and/or boost revenue.  As firms examined the costs embedded in their inventories and the management of their supply chains during the “Great Recession”, this process of experimentation led to a clear preference for certain types of warehouse space as part of the solution to manage costs.  Understanding and following these changes can help commercial real estate investors in their pursuit of returns in the industrial sector.

Demand for warehouse space is now clearly back into positive territory.  Net absorption figures from our CBRE Econometric Advisors unit for the 1st quarter of 2012 show that demand for warehouse space across 60+ major markets came in at just over 26 million square feet for the quarter.  To put this performance into perspective, demand has now been positive again for the last seven quarters but it is still not at the peak 40 million square feet per quarter pace set from 2004 through 2006.  The anemic recovery in the overall warehouse market aside, modern big box space outperformed the warehouse market overall throughout the market downturn. 

Demand for warehouse assets built since 2000 with at least 450,000 square feet of net rentable area remained positive throughout the Great Recession.  Even the multi-housing sector, which arguably has fared the best across sectors during the downturn from a return perspective, cannot tell such a healthy story around fundamental demand for space.  The following chart breaks down the net absorption of warehouse space and it is clear that the recovery to date in the warehouse market is dependent on this modern big-box space.


Tenants were focused on cost-containment during the “Great Recession” to a far greater degree than they had been in the past due to cash flow issues in a world where credit was suddenly cut off.  While the warehouse market overall lost ground in 2008 and 2009, this subset of assets 450,000 square feet or greater saw 35 million square feet of demand per year because of cost savings offered by the space.  Retailers concluded that holding vast inventories on the shop floor required them to tie up too much capital in one location.  By keeping a higher proportion of inventory in the warehouse at the ready when needed by stores, retailers able to shrink inventories to a more manageable level and run their operations in a more capital-efficient manner.  The concentration of inventories helped to facilitate demand for larger warehouses that could handle higher throughput.

Beyond the activities of firms, consumers have also been cost-conscious in recent years and in turn, this change in consumer activity has shifted the nature of the demand for industrial space.  The electronic shopping category has grown exceptionally well even as other sectors of retail faltered.  As shown in the following chart, while spending on some elements of retail are not back to their previous peaks from before the “Great Recession” spending in the electronic shopping world is now 41.4% higher than the previous peak.  By contrast, spending on discretionary items (e.g., clothing, electronics…) is just now back at the previous peak levels.

An element of consumer demand shifted from the shop floor to the internet during the “Great Recession” as the tools of electronic shopping allowed more comparisons and better price discovery for consumers.  The fact that many online purchases can also skirt state sales taxes also helped to push an element of consumer demand on to the internet as consumers are increasingly cost-conscious.  This shift however required e-commerce retailers to take on much more space to handle the order fulfillment and invariably, these tenants required the modern, large warehouse assets that generated efficiencies for distribution.

However, while economic and business dynamics have pushed demand for space onto a particular type of space, there are only a limited set of markets where these large modern assets are concentrated.  The following table highlights the top 21 markets in the U.S. for this activity as measured by the square feet per capita.  This benchmark is relevant as markets with a comparatively high ratio of square feet per capita are those where the economic activity focused on these assets is essentially being exported.  While there is some modern big box space in many markets across the U.S., these 21 markets have a ratio of square feet per capita greater than 3.2, the national average, and are thus important hubs for this activity nationally.


Savannah and the Inland Empire stand out in this list not only because this square feet per capita metric is so large in each but also because of just how important this space is to the overall warehouse markets of these metropolitan areas.  Again, nationally this space accounts for only 6% of total warehouse inventory.  In these two markets the space accounts for more than 20% of all warehouse inventory.  Both of these markets have a clear connection to port activity and global trade and in addition to the other factors cited, this expansion of trade and the importance of port markets as entry points for the shipment of goods to the U.S. economy also creates demand for this big box space.

This demand has been strong enough to push the availability of big box space to single-digit levels in certain of markets, which in turn should generate above average returns.  Consider for instance that in the Inland Empire market that the CBRE Cap Rate Survey listed cap rates for stabilized high quality warehouse assets coming in around 5.25% as of the end of 2011.  Combine this going-in level with the forecast of average 6.5% per year rent growth in the Inland Empire according to CBRE Econometric Advisors, and for the market overall, one can easily make the case for unleveraged returns just under 10%.  For this big box subtype though, the income gains are potentially much greater.

As shown in the following chart however, the availability of space is now well into the single digits.  This segment has seen net absorption of roughly 4.8 million square feet per year over the last two years.  This low availability now puts the market down to only one year’s worth of supply for this type of space.


If tenants are going to continue with this cost-management solution that has worked so well over the last couple of years there will need to be some adjustments in the current market.  In key hubs there simply is not enough space to go around.  Some firms may find an ability to locate to space outside of these key hubs but it is not clear that many markets have substantial inventory of this space.  Alternatively, tenants may begin to pay more and more of a premium for this segment as the price mechanism is used to ration the limited supply.  As such price changes occur, it is possible that this big box subtype could see far stronger rent growth than the warehouse market overall.  This change is in fact leading developers to begin to introduce more of this space, but the single-digit availability rates in key distribution hubs suggests there is still room for growth here.​​​​​​​​​​​​

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