Step by Step: Prologis on the normalization of industrial real estate

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Spencer Levy
The pandemic era ushered in something of an industrial real estate revolution. Huge growth. Historically low vacancy rates. Global logistics redefined. Supply rising to keep up with skyrocketing demand. If you put your money on industrial in recent years, you simply couldn't go wrong. I used to call this the land of milk and honey, as long time listeners may recall. And while it hasn't entirely soured, the last 24 months have seen a downshift in industrial markets. On this episode, the world's largest industrial investor and the long term path for growth across the sector. 

Melinda McLaughlin 
There's still activity out there. There are RFPs. There are tours. There are proposals. But everything seems to be moving through the pipeline a lot slower, with a lot more resistance than it used to. 

Spencer Levy 
That's Melinda McLaughlin, Senior Vice President and Global Head of Research at Prologis. The US based REIT, founded in 1983, that has grown to 1.2 billion square feet in 19 countries, leasing modern logistics facilities to roughly 6700 customers worldwide. 

Chris Riley 
The occupier world is tapering right now. I don't think it's going away, but it's certainly tapering and it's rationalizing more. We are from an economic standpoint and the overall economy. 

Spencer Levy 
And that's Chris Riley, President of Capital Markets, Industrial and Logistics for CBRE, who leads our platform for the sector. During his three plus decades, Chris has been involved in deals covering more than 831 million square feet of real estate, including transactions in 77 markets in North America and more than 200 different purchases. Coming up. You won't find more experienced industrial insiders anywhere on the planet, folks. Prologis and the world of global logistics. I'm Spencer Levy, and that's right now on The Weekly Take. Welcome to The Weekly Take and we are joined by Melinda McLaughlin. Melinda, thanks for joining the show. 

Melinda McLaughlin 
Thanks for having me. 

Spencer Levy 
And then Chris Riley. Chris, thanks for coming out. 

Chris Riley 
Likewise, Spencer. Happy to be here. Thank you. 

Spencer Levy 
The industrial asset class has been on a great run for a decade, but I think it's also fair to say it's gotten a little slower in the last year and a half. Melinda, would love your take. 

Melinda McLaughlin 
So, what is the state of the market today? I think a lot of folks are trying to figure it out, given that it has been kind of a consistent up and to the right story. What we think, if I were to summarize, is really it's just about the market getting back to normal. I always say the pandemic was not normal vacancy getting down to 3%. It's tough to have a functioning supply chain with logistics, real estate vacancy at 3%. Again, not normal, so we're getting back there. Also, we see users in particular adjusting to the new economic environment. So, that has to do with interest rates, labor, other costs as well as continuation of those structural shifts. So, it's all coming together at once, both the repercussions or the echo of the pandemic, along with just a continued trajectory in terms of changing supply chain needs. 

Spencer Levy 
Chris, same question. Big picture. Where are we? 

Chris Riley 
First, I would just say that when we shifted to a same day, next day, two day delivery platform, that's really when our market took off and industrial became the belle of the ball. And then secondly, I look at it through the investor lens too, industrial sector is one of the best cash flow businesses in the four sectors. If you think about how capital intensive office is and how little capital has to be invested into industrial year over year, I think that's been an attraction. And that's why the institutional investment community woke up and decided that they wanted to be a big aggregator of industrial. 

Spencer Levy 
Chris, let's stay with you for the moment. Let's get into where the market is today versus, say, where it was 18 months ago. 

Chris Riley 
Well, we certainly see a deceleration of what's happening from an investment standpoint. Spencer, if you look backwards, we were at $182 billion market back in 2021, the unicorn year. And then last year we only did 91. So, basically a 50% sell down from where we were in 2021. This year doesn't look that positive. We found our footing in the first quarter, and there was a lot of positive investor sentiment and a lot of things that pointed to if we achieve those rate cuts that people predicted, there was a lot of belief that we would actually break through a 100-plus billion dollar deal here this year. It doesn't feel like that right now. The sentiment is, I would say, transitional and very edgy, and people are concerned about both the occupier side, which Melinda alluded to. And then on the investment side, how do you price the equity cost of capital right now, especially in a marketplace that's seeing the debt cost of capital, it's very available, but it's obviously seen an expansion that's not affordable where yields are currently. 

Melinda McLaughlin 
I think Chris is absolutely right about the capital markets. I think we are in a bit of a flip flop. And until that transaction activity starts picking up, I think there's still just going to be a question about what is the right value. I think from an occupier standpoint, most things are playing out as we expected, right? We definitely expected the vacancy rate to go up. We had a pipeline 18 months ago that was about 500 million square feet. So, the largest ever. It's roughly half that today. So a lot's changed, I would say in the development environment, with those same interest rate increases flowing through the cost of capital and really pulling down the starts. So, we can see a clear pattern and path to rebalancing but where we might be surprised is just some of the deals on the rent side being cut today. There's definitely a little bit less patience, maybe a little bit more anxiety about the same things Chris picked up where it's uncertainty, and I think we have a market that's really looking for a floor for values, a floor for rents in particular markets and more clarity to go forward. 

Spencer Levy 
And I think it's that lack of clarity, Chris – correct me if I'm wrong – that's really the number one issue, but is that the only issue or the major issue? And if not, what do you see as the issues in the market at the moment that are keeping it up in this sort of never never land? 

Chris Riley 
Yeah, I would say the first issue, Spencer, is just the lack of predictability. When you think about the institutional owner investor, they want a solid footing market with predictability and we've had anything but that in April yet. And if you think about last year in the third and fourth quarter, it was very volatile and it was volatile on a daily basis. The credit markets were upside down, we saw anywhere between 5 to 10 basis points of change in the 10-year indice, daily, and that's something that you follow very closely. And that volatility and lack of predictability is causing a lot of stress in the marketplace. And on top of that, Melinda's alluded to, as well did I, the occupier world is tapering right now. I don't think it's going away, but it's certainly tapering and it's rationalizing where we are from an economic standpoint, the overall economy. So, you've got two pressure points in the marketplace and those are coming together. And unfortunately we've got a market that's fairly fragile. 

Melinda McLaughlin 
Yeah, I think it's really about the way the fed is constructing this landing and ultimately the impact on consumption, right. That's the primary driver of this business. And, so, if you have uncertainty about the path and your sales projections going forward, I think you're going to avoid any capex spend right now. Again, capital's dear I think customers are under a ton of scrutiny from Wall Street. And so what we see is a lot of delayed decision making. There's still activity out there. There are RFPs There are tours. There are proposals. But everything seems to be moving through the pipeline a lot slower, with a lot more resistance than it used to. So, I think that all goes back to this uncertainty question. When that gets resolved, I think we'll actually see some pent up demand being released, because we've been digging deep into the demand side for a very long time here at Prologis, frankly, I have three different ways that I look at demand. All of my projections are actually saying we should be getting more than we currently are. 

Spencer Levy 
So, Chris, let's use that same phrase that Melinda used on the occupier side, on the capital side of pent up demand. Do you see that pent up demand, Chris, coming back into the market? And, if so, why don't you walk us through the different types of investors you're seeing being most active? 

Chris Riley
What's very interesting, Spencer, when you look at the first quarter of this year, basically all of the institutions that were on the sidelines last year, which was the majority of the weight of the capital, were back in the game. And the only major exclusion is going to be the Odyssey open ended core funds. Now, for the most part, they have very limited capital to invest or deploy right now because they've been facing redemption cues, which given the recent marks, those are coming in line and I think it will free their capital up towards the third and fourth quarter, hopefully that they'll join the game on investing as well. I'm going to give you some green shoots because we had anything but that in the third and fourth quarter of last year. So, every deal that we had – and I would even say our competitors are on the same page as us – throughout the first quarter and even through April that was supposed to close, scheduled to close, closed. Not one deal was retraded, nor was a deal asked to be retraded, which was anything but again during the third and fourth quarter of last year. Our book of business – although right now, if you look at the first quarter, it's below the first quarter of last year, so we're down 20% year over year nationally. But, our book of business for the second quarter looks very strong given the BOVs that we've produced to date and more importantly, what we have on the market in bid process. So, we're actually a 2x of over where we were during the first quarter. So, I do believe that weight of capital that you described is activated and we’ll still be a market participant. 

Spencer Levy 
What's happening today is a lot of nearshore and new manufacturing activity coming back to the Americas. I don't just say the United States of America. And, so, talk about that for just a moment. How much is the change in globalization impacting Prologis’s point of view? 

Melinda McLaughlin 
Yeah, we see clear evidence of nearshoring. We actually track a number of leading indicators and see it continuing. Right. So, capital goods actually being imported into the country to build up these new manufacturing facilities is a great leading indicator to watch. And what we've seen is as all of that investment has taken place, demand is roughly 2x pre-pandemic along the border in Mexico. So, this is really substantial for those markets. A lot of them now have vacancy rates below 1%. It's one of the places in the world where you're still seeing double digit rent growth, right, in some of these micro locations. So, a really powerful kind of countercyclical structural force going on where there frankly isn't enough space. And, so, you probably know, energy is the big constraint in getting access to that infrastructure. So, while I think that there's a lot of desire for there to be more activity, more development, accommodate this. We're definitely seeing the market come up against some practical constraints. 

Spencer Levy 
Well, it's interesting, Chris, that Melinda brought up energy because I was going to bring that up as terms of our limiting factors moving forward. In more of these conversations, we're getting limiting factors of energy, water, and but really a lot of distribution as well. But, I think a lot of that is related to the heavier manufacturing space. But, some of it's related to data centers. Most of our traditional industrial investors don't really invest in manufacturing. They may now be getting into data centers. And I've always questioned, well, why don't they get into it more. What's your point of view, Chris? 

Chris Riley 
Well, I think the reason why they don't get into heavy manufacturing, it's very purpose built, and the reusability or durability of those buildings is very limited if that occupier moves out and vacates that facility. And, so, that's the problem with manufacturing. I think what they will invest in, right on the edge of that definition is assembly. And assembly makes a lot of sense. But, when you get into heavy manufacturing situations, again, those buildings are so specialized and purpose built, it makes it very difficult as a long term owner. And that's why the vast majority of that real estate is owned by the occupier. 

Melinda McLaughlin 
So, we get the question about onshoring a lot to not just near but obviously within the US borders. And as we all know, right, it's specific industry is definitely helped along by the government. We did a study of one of these investments in Phoenix semiconductors and I just asked for all the RFPs and what came in was some for leased space, right –  1 million square feet or so. But, when you dug underneath the surface, they were looking for land or maybe existing buildings for purchase that was roughly 12 times that much. So it makes sense both from the investor standpoint and that, you know, this – there are concerns with heavy manufacturing as an investment, but also from the occupier. These are mission critical, right? You don't want to be, I think, at the whim of a landlord when this is like your core activity. So, I think what we'll see with manufacturing investments both along the border as well as inside the United States, it's really the removal of competitive supply for some of these micro locations. Right. That's 12 million square feet of land that's going to go to production, chemical parts, the whole array of things you will need for that, that is not now going to get turned into a distribution building. 

Chris Riley
One more comment on that. If you think about it from an investor audience standpoint, the best outcome in the – even though it's a very narrow swim lane, the deepest part of that swim lane being narrow is really a CTL financing structure, because that allows for the owner to be there for 20, 25 years, align with that term that the occupier thinks they'll need that facility for and then they don't have any more ownership obligation. So, I think that defines why it's so specialized, because it takes also a specialized structure that aligns that interest. 

Spencer Levy 
And just for our listeners benefit, CTL stands for Credit Tenant Lease. I heard my producers ringing in my ears before you even said, it's like, oh, I got to define a term here. So, that's all good. So, let's talk about the acceleration of trend due to Covid. We already talked about one acceleration of trend due to Covid, which was this magic year 2021 where all these sales got pulled forward. But the other thing that got pulled forward was internet penetration and internet penetration and retail sales spiked and then actually went negative, but now may renormalize the trend. So, Melinda, from your point of view, from your research point of view, have we reached peak internet penetration or are we just going to continue to clip along at the rate that we did pre-Covid. 

Melinda McLaughlin 
Somewhere in between there. So firstly, the trajectory of e-commerce did not surprise us at all. We tracked the surge obviously very closely in my department, and saw, you know, this is probably likely to be a temporary phenomenon while in-store retail figured out how to navigate Covid. And, so, that surge and then coming back down to earth really, I think was kind of a ‘22 phenomenon. And even as early as mid last year, we started to see the penetration rate re-accelerate for e-commerce. It didn't ever go back to 2019. So we went up. We gave a little bit back. But we're still, I think, further along on the e-commerce journey than we would have been if it weren't for the pandemic. So, that's one thing. And that means today when customers are making – our retail customers in particular – when they're making supply chain decisions, they have to accommodate the fact that volumes are permanently higher. I call that kind of a permanent multiplier effect from that accelerated pandemic growth. And, so, while we did see that plateau, the quarterly data would tell you it's speeding back up again. Online sales are now again outperforming in-store retail. I don't think it's going to be the same rate of change, given that we had so much over the past few years. Essentially, the denominator is bigger, right? So, the growth rate is going to come down even if in absolute dollars and absolute parcels, we're still seeing very strong growth. So, I think we have a bit further to go. We're not at peak e-commerce, there are still under penetrated segments and we continue to see consumers say that's what they want. But I think more and more traditional retailers are just adapting and it's really becoming a true omnichannel experience rather than pure play this or pure play that. 

Chris Riley 
I want to point out something on the investment side that dovetails on what Melinda was talking about. It was a hockey stick market due to the Covid phenomenon in 2020. So, we had four months of straight down with obviously a very murky marketplace. And then if you think about what started in July, it was anything but straight up an acceleration and all of the players, investors came off the sidelines. And that predated obviously, the unicorn year of 2021, which is the hottest year ever. So, I'm a big believer that the recoveries will be shorter. This has been such a volatile market for the last 18 to 24 months. We can't find the footing. If we did, I think we would have the same kind of recovery. 

Spencer Levy 
We talked about scarcity of electricity, scarcity of water, but we didn't talk about the scarcity of labor. Unemployment rate in the United States today is still sub 4% and it seems to me that that is the factor that is challenging, where a lot of people are choosing to locate their manufacturing facilities, but also distribution. How do you see it, Melinda? 

Melinda McLaughlin 
Yeah, we've been hearing about labor costs since I joined Prologis back in 2015. We – even then the unemployment rate was getting pretty low and it was a challenge for customers. E-commerce uses multiple of the labor of a traditional palletizing distribution operation. So as that segment grew, and particularly you're soaking up a ton of labor in all of these distribution hotspots and distribution facilities tend to cluster for very logical reasons around transportation connections and trade gateways, as well as where people live. So, you have this problem where a lot of activity is essentially all very close to one another. And, so, that means you really can run up against a labor market that's just tapped out. So, we started underwriting every new building we do. The labor availability in the proximate area, about, gosh, probably 2017, because we had been hearing about this so much from customers. We also introduced the Community Workforce Initiative, which is now migrated to more of a virtual training program that can reach many more people to try to get this early pipeline of logistics labor going. I think you're right, unemployment's super low. It's still a challenge. It's still going to be part of the site selection exercise. 

Spencer Levy 
So let me make a comment. When you speak to our large occupiers, they say, well, we're in the office, an industrial business. That's what we do. Well, a lot of my retail clients open in retail, expanded into multifamily, and they did it to get more customers to their sites. And my suggestion was, well, if you're having a labor shortage, why don't you get a little bit into the multifamily business so your people have a place to live, and I can give you 20 different case studies on how some large occupiers have, in fact, done that. Is that a place we're going, or was that still a step too far? 

Melinda McLaughlin 
I love your creativity. But, I think it brings up another thing that we're just seeing more and more, which is regulatory resistance to logistics buildings. People don't want to live near a logistics facility. I think that it makes sense for some reasons. I'm optimistic that we'll be able to coexist better in the future with a lot of sustainability investments in the EV transition, but I think today it's still just a sticking point where your workplace tends to be a lot further from your home relative to maybe retail or office, but you never know. I think there's a lot of great technologies and new solutions out there, so perhaps we'll see it someday. 

Spencer Levy 
Maybe I want a bridge too far in multifamily. But let's go back to something else that Melinda mentioned, which is, people don't like to have industrial facilities near them. And the reason isn't because they don't want their packages the same day, they don't want 18 wheelers going through their neighborhood. Which brings up the question of the repurposing of second generation office. And we have seen a lot of that in the mall space. We've seen knockdowns of people building industrial sites. Do you think we're going to see that in the office sector? Chris. 

Chris Riley 
We've already seen it. Office is not oversupplied, it's just under demolished. So, there are office buildings that don't have a purpose. They were not designed or you could readapt them to multifamily or some other use. So, depending on the amount of acreage that you have and whether or not the site lays out symmetrically for an industrial building, there are office buildings that are being torn down. If they are suburban office parks, that's the best framework because that obviously has the total size that can obviously build a very functional industrial building. So yeah, there's office parks that are falling the trend for defunct malls. 

Spencer Levy 
Can I get a little tactical for just a second? Because I think we're going to have people listening to this say, well, I'm going to sell my office building the largest. What are the key characteristics of a building, you say, you know, this one might be a candidate for that.

Melinda McLaughlin 
Gosh, we've been getting this question since back in the day about the malls. The main thing we find is that it's really – the whole site is not designed for a throughput operation, right. Malls in particular, I always say they're designed to keep people in, not move things through. And, so, I would say the same thing would apply to an office location. In addition, any conversion is just going to be more expensive than greenfield development, right? It just always is. And, so, it will probably only make sense in areas where land makes up a really high proportion of the overall development costs. So that, to go through the rezoning, any kind of demolition you need to do to make it worth your while, it's really about capturing the value of that location. The value of that land tends to be closer to urban centers, highly built out dense areas, and with really good transportation links. So, an irreplaceable location. 

Spencer Levy 
So, this is the future looking question of technology and where are we going? Number one multi-story industrial. We see some of it – Seattle, Brooklyn, Wilmington, Delaware. 

Melinda McLaughlin
I mean those properties are in operation doing last mile delivery. We do see signs that there are customers willing to take that space for the premium location. It's very much like the conversion story, which is, it's only going to make sense in certain places. I think in the US anyway, one of the hurdles we had to overcome was users being comfortable with the new layout, because we're very much used to like the ranch style warehouse, going vertical with something new. But we see that it works, and it's going to be, especially as I think customers have to turn back to service levels. Let me rewind where during the pandemic, I think the main priority was getting your hands on your goods. Right? There were so many supply chain disruptions that we really saw demand concentrated at the ports. Inventories surge. So, bigger was better. Bulk facilities. And I would say the true infill in these coastal metropolitan areas or inland metropolitan areas lagged a little bit. Consumers were willing to wait a few extra days. And I think that dynamic is shifting back to what it was before the pandemic, where there's a lot more competition for consumer dollars, whether you see it through discounting, sales, promotions, service levels. And, so, I expect a refocus on getting close to and consumers realizing those carbon benefits, those cost benefits, as well as better service levels through things like fast delivery times. So, I think we'll see continued evolution of the multistory space. Very little can be done now, as Chris probably knows, until values are very clear, right. All the inputs to a development equation need to be a bit more visible and certain for all the different players to, I think, really get that engine going again. But, I certainly expect urban economies will remain urban economies and there are big benefits to making those types of developments work. 

Chris Riley 
Well, obviously, we've seen technology change the envelope of the building greatly, mainly through the clear height, the columns facing the truck court. And as Melinda talked about earlier, is just the functionality that's required around additional truck parking and auto parking. I would tell you, the technology in the building that I think will be one to watch, and Melinda can comment on this too, is it's going to be a uniform material handling equipment system. Right now it's very specialized around the size and weight of the goods. And when they can reach that, to get to where you can allow for many types of different products – both by weight, by size, to be able to leave that material handling, conveyors, all those systems in a building – then I think we've got something. Because the cost of that is typically equal, if not greater than what the envelope of the building cost. And to this point, we've not seen durability around that or sustainability. Usually when that occupier vacates, some developer owners might hold on to that racking. You think there's utility, but a lot of times it's so customized and specialized that's not the case. And I think that will be a big pivot point in the marketplace when we find someone who can accomplish that. 

Melinda McLaughlin 
We've been tracking automation within our facilities for a while. The growth right now is really in mobile and modular, and there's logical reasons for that. I think highly customized systems. We have talked with a lot of customers that did a big investment in the 80s, and it did not pan out because it wasn't flexible. If your product changed, if your business changed the machinery, the material handling equipment could not change with it. So, what we see today is autonomous mobile robots, palletizers. When you start to break down the operations in a logistics facility to the component parts, there are these new technologies that can be in some cases leased one by one, experimented with. Many of them have a terminal value because they're flexible enough to be sold to another user. And, so, that's where I think we see more growth. And we've studied the impact on the layout. There are somewhere you might be able to get a bit more space efficiency. So, robots going down a hallway might take 10% less hallway, right, compared to humans. But most of them are really focused on other KPIs – speed, accuracy. Even safety for workers are the primary benefits of adopting this where I would say some of these technologies take up more space. So, charging for the robots now is like a whole section. I think we'll continue to see that be the growth area. And, so, when we think about what does that need from a logistics building, the modern shell as we have it today can accommodate most of that. I actually don't think we need a ton more changes, but I would be keenly focused on the infrastructure around. So, the data and the power, I think all of that will just become more and more important to traditional logistics operations, as well as all those other types of industrial uses, whether it's manufacturing, light assembly, data centers. I think the energy demand side of the equation is just going up. 

Spencer Levy 
Let's turn for just a moment to a tragedy which just occurred. I live in Baltimore. We saw the terrible tragedy with a boat taking out a bridge. And it makes me think not just about my own city, but it makes me think about how vulnerable we are elsewhere. And it brings up another R-word, which is redundancy. So, Chris, when that happened, what was the chatter in the business of logistics, of how this upended patterns? And do we need more resiliency when it comes to these types of things or redundancy, better stated, to avoid disrupting supply chains as a result? 

Chris Riley 
Well, you think about the time, the resiliency to do that in key infrastructure. If we do have a tragedy like what you just described, those are long term projects to repair or replace. So, I don't know how you plan for that other than being ahead of the curve always when it relates to your infrastructure. So, whether they're bridges or major thoroughfares, ports that need updating, those are things that take a lot of focus and a lot of long term planning. You know, the byproduct of that, obviously, other ports up and down the East Coast are a beneficiary in the short term, but eventually we'll get things righted and the Baltimore port will get back to normal levels where they were before. But, Spencer, you're talking about generational type issues when it comes to our infrastructure, both from a water perspective, from a transportation perspective, with key bridges and other roadways. 

Spencer Levy 
Well, let me bring it back to the Covid crisis when supply chains were disrupted. We heard more talk about people saying we're going to increase our inventory levels from 3% to 6%, and I don't know if that actually occurred, but that was the discussion that we would need more industrial so we can have more inventory on site. That's it. The form of redundancy that I'm talking about. So, while in the same basic question, which is the redundancy question, the chatter you heard after the bridge collapse, and do we think your customers are adding more inventory to their existing or needing new sites? 

Melinda McLaughlin 
It's a great question. And we heard the same thing, right. I always said inventory and holding more inventory was something accessible to 100% of customers. But, there are other ways to building resilience. One, is to hold more inventory. And I would tell you today, inventory to sales ratios – and we exclude auto because it doesn't generally go inside a logistics facility, but they're below 2019 levels. So, customers are not holding more inventory relative to their pace of sale. Part of that is because sales have surprised to the upside. So, I do believe when there's obviously a big lag between ordering and when, especially peak seasons happen, there's been a true surprise there. And that's part of why we've seen import volumes be so strong through the first quarter. Is that companies – I always say probably some of them have had over destocked, so cut inventories a little too much. But what's really changed between, I think the time we were having those conversations and today, two things I think supply chains, despite the continued disruptions, are more predictable and less costly than they used to be. But two, the thing we started this conversation with, interest rates are higher, costs are higher. Uncertainty is higher. We've studied this in the past, before sales ever start to fall, generally, we see inventories being cut by like 2 to 3%. So, simply the anticipation of potentially a slowdown causes companies to become more defensive with their inventory strategy. So, I do believe especially in ‘23 where we started the year and everyone was pretty sure we were gonna have a recession, that there was that defensive inventory management. So, we'll see where this balances out. I think what has become clear is supply chains are not going back to highly predictable. We published a piece back in 2021 on this, where it was sort of like when the pandemic's over, will this need vanish? And when you look at the megatrends, one is geopolitics. I think we see plenty of evidence that it will probably continue to remain more volatile and more unpredictable than it was perhaps in the 90s, in 2000s, when there was that period of a lot of globalization. If you look at labor, in developed nations and some developing, right, we are going to have way more consumers than we will have workers. And, so, that's going to put strain on the labor market. We see that through strikes, disruptions at the ports, things like that. That will continue as a trend. And, then, finally weather related disasters. I think we see obviously the Panama Canal as being indicative of something that will continue to plague supply chains. So, when you add all that up, right, disruption isn't going away. Your strategy to how to accommodate it might evolve with the economic climate. Inventory is one avenue, diversified sourcing is another. So, we talked about nearshoring. And then the final is just making sure your supply chain is diversified as well. So, having the ability to pivot and run your network through another coast, for example, when the West Coast got jammed up, right, we saw a lot of activity shift to the east and customers really, I think, gained an appreciation for having the ability to pivot when they need to. And I think that's a permanent shift. 

Spencer Levy 
Chris, from an investment standpoint, Melinda just touched on, I mean, some of the biggest issues in the world as it relates to how they impact logistics patterns. But from an investment standpoint, are you seeing our clients try to diversify their holdings in part to respond to this, or are we still at the beginning of this game? 

Chris Riley 
I think we're at the beginning, but I think the diversification, Spencer, is really around looking at you mentioned this earlier population base and then population growth. And, so, if you think about it, the office market is really toggled off of labor and employment growth within a marketplace where when you look at the baseline most important metric for industrial, it's all about population, existing population and population growth. And, so, therefore, the small market seem to have the majority of investment capital to be deployed right now because they're looking at states that are growing in population. And there's a lot of reasons why those states are growing, but that seems to be the underlying baseline that investors follow. 

Spencer Levy 
One other just straight question on just cost. So, I don't think our listeners realize the level of disruption that we saw during Covid, not just in terms of the volume of goods, but the cost of the – here comes the word – TEU, twenty-foot equivalent units, those boxes on the boats. The twenty-foot equivalent units, I understand, peaked out at close to $20,000 a box to go from China to San Francisco. Then they troughed to around $1000. Now, I think they're back closer to $2000, in part due to geopolitical tensions. And Melanie, you look at this thing globally. How does that impact logistics patterns? 

Melinda McLaughlin 
This is one of those where it's counterintuitive. We get this question a lot. When transportation costs go up, won't logistics real estate feel the squeeze? Because all that money is now going to a different part of supply chain costs, when it's exactly the opposite, right. Again, you could have avoided those surge pricing if you had more inventory and if you have the ability to go where costs are more favorable in times of disruption and scarcity. And I would say specifically on the transportation component, if you're decentralized and you have lots of touch points in your supply chain, you can minimize the reliance on outside partners. Yeah, if you think linearly, you would think, hey, this is eating up part of the cost stack that could go to logistics, when instead I think it's incentivizing a more resilient network and I think we'll continue to see that just because costs have come down now. I mean, we saw it with the Russia invasion of Ukraine, where our European customers saw their energy costs 10x in a very short amount of time. We got a lot of calls about renewable energy then – I think that that's a permanent lesson learned. So, we continue to see elevated interest in renewable energy in Europe even though costs have come down. One thing I'm just constantly watching is what lessons are learned and sticky, and what might be subject to more of a short term memory issue and might reemerge later on. And I think this is one where on the inventory side, there might be a little bit of a short term memory. We've got pressure on our margins, and so we're going to make some trade offs. But over the long term, I think evidence will continue to stack up in favor of resilience. 

Spencer Levy 
Melinda, from your point of view, where are we going for the next three years in industrial? 

Melinda McLaughlin 
I think that things have turned industrial into mission critical for our customers and an outperformer for investors. You know, we get back there. Well, I've been calling this a supply driven mini cycle. We had less elasticity between demand and supply during the pandemic than we have ever experienced. We had a surge in demand. We're on a delay in terms of bringing on the new supply to satisfy that. And, so, we're going through that right now. We're bringing in all that new product. Markets are rebalancing, and we're finding the right pricing level to allow for a smooth functioning supply chain going forward. But, we're going to continue to see supply chains be mission critical to folks. We're going to continue to see change in investment, for resilience, for sustainability, for better service, to fulfill the e-commerce promise and all the other types of ways our customers are generating business. And, so, I'm optimistic in the long term, I think it's going to be more challenging out there to bring on new product. So, I expect, actually, that elasticity to go down in a structural way. But that means for those who can make it happen, there's an opportunity to really help customers succeed and I'm very excited about that. And that’ll have implications for technology and data, and I think the world is just getting more interesting in the ways that we can bring efficiency and productivity to life. 

Spencer Levy 
Chris, final thoughts from you looking forward to the next couple of years for industrial? 

Chris Riley 
Well, I agree with Melinda. I do think we're at an imbalance from a supply demand standpoint. We've got an oversupply that is going to be temporary for the next 12 to 18 months because we have seen the occupier tap the brakes a little bit. But I do think once we get to 18 months, end of 2025, I think the market will be really healthy. And I think that we'll be back at peak occupancy levels, which will really set the tone for what will drive market rents again. So, I think the market is very healthy. I think it has also been the outperformer from the last ten years, and I expect the sector will do so for the next ten years. It is a great durable cash flow business and I think that's why investors like it. So, I'm very bullish on it in the long term and I think technology will only make the industrial sector that much better as we move into the next ten year span. 

Spencer Levy 
Well, thank you, Chris. And on behalf of The Weekly Take, I want to thank our two terrific guests, starting with Chris Riley, President of Capital Markets, Industrial and Logistics, CBRE. Chris, great job. 

Chris Riley 
Thank you. 

Spencer Levy 
And I then want to thank Melinda McLaughlin, Senior Vice President, Global Head of Research at Prologis. Melinda, terrific job today. 

Melinda McLaughlin 
Thank you. My pleasure to be here. 

Spencer Levy 
For more on industrial, including related content on the sector, please visit our website CBRE.com/TheWeeklyTake. We'll be back next week with an exploration of how forecasting works, to help you better understand all those projections you read and hear about. And we'll also delve into technology, AI, smart cities, and more. For now, please share this episode and don't forget to subscribe, rate, and review The Weekly Take on the platform of your choice. We look forward to spending time with you again next week. Thanks for joining us. I'm Spencer Levy. Be smart. Be safe. Be well.