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There hasn't been a lot of good news about the U.S. economy in recent weeks. Recovery appears to have stalled, and economic growth this year is shaping up to be less than expected. It's going to be some time before we shake off the effects of the latest Great Recession.
Recently, though, we've seen a glimmer of hope in one of the areas that was hit hardest by the crash: the U.S. industrial real estate market. The latest Industrial Business Indicator report from Prologis sees increasing demand for logistics space, driven by inventory growth, over the next two quarters.
That view is echoed by the Spring Industrial Outlook of Jones Lang LaSalle, the Chicago-based real estate services firm. It reports a nationwide drop in industrial property vacancy rates, with particular strength seen in California's Inland Empire, the area around Chicago and Central Pennsylvania. Leasing activity is also picking up in Atlanta, Dallas, Miami, Phoenix, Seattle and Denver - all important logistics hubs.
We shouldn't get too excited, though. It's only the beginning of real recovery in the sector. New construction remains "muted," according to Jones Lang LaSalle. "We are still in a relatively slow-growth economy," says Craig Meyer, the firm's international director. "We really need to see strong leasing activity in the second-tier markets before the industrial market returns to full health."
So what could give the industrial property sector an extra shot in the arm? The Panama Canal expansion, for one. Talk of the widening of the canal and the addition of a third lock by 2014 has mostly centered on the project's expected impact on ocean-shipping routes and the U.S. intermodal system. To be sure, we can expect a surge in the popularity of all-water services from Asia to the U.S. East Coast, with the new canal able to accommodate ships of more than 12,000 twenty-foot equivalent units (TEUs). But there's also a strong real-estate angle to be considered.
Along with increased container-handling activity at East Coast ports comes the need for supporting infrastructure inland. Facilities such as the Virginia Inland Port, an intermodal and distribution hub for the Port of Hampton Roads, have managed to carve out an important market niche. Now they're in for an additional boost. "Ports require the development of off-dock real estate," says John Carver, executive vice president with Jones Lang LaSalle. "A place for cargo to grow."
Inland logistics facilities were a big deal only a few years ago. Speculators began forming real estate investment trusts to build out property for warehouses and distribution centers instead of just shopping malls. All that came to an abrupt halt with the recession, but the need for a place to stock and centralize inventories is coming back.
Carver believes the Panama Canal expansion will spur the development of new logistics projects. Cost-conscious shippers have turned to fuel-efficient all-water service as a means of offsetting soaring energy costs. Expect that trend to continue. Carriers, too, are taking steps to save on fuel, if not in a way that pleases shippers: they're slowing down their ships.
"Slow-steaming will result in a slower supply chain and the need for a larger amount of products stored on land," explains Carver in a recent Jones Lang LaSalle report on the canal's impact on U.S. industrial real estate development. "This is turn will mean that shippers will need to expand their space requirements to ensure they have ample inventory on hand." More distribution centers will also be needed to make up for fewer direct port calls by the new generation of mega-ships. So much for the theory of just-in-time (JIT) distribution, which relies on the rapid fulfillment of orders with minimal inventories on hand.
Finally, shippers are likely to increase their use of the all-water option in order to avoid relying too heavily on the West Coast as a gateway for imports from Asia. That all-eggs-in-one-basket approach proved disastrous during the West Coast labor lockout of 2002 and port congestion) of 2004.
And where will we see these additional logistics facilities in support of the shift? Increasingly, in the East and Midwest. Because bigger ships are cheaper to operate on a per-slot basis, carriers will find it economically feasible to reach deeper into the U.S. interior from the East Coast. Discretionary cargoes, which previously went no farther than Memphis, will extend as far west as Dallas.
As always, there could be some wild cards hidden in the deck. The public infrastructure funding crisis could severely hinder development of the roads and bridges that are needed to link inland distribution centers with marine terminals in an efficient manner. Carver likens the current system to a barbell, with the port at one end, inland facility at the other, and rail and road connections making up the narrow handle. If the President and Congress can't break the political stalemate around highway funding, hopes for the growth of new logistics centers in the interior could be dashed.
Meanwhile, with the expanded Panama Canal due to open in just three years, private money is flowing toward the logistics sector. "There is a considerable amount of capital that's ready to be deployed," Carver says. The first investment wave will focus on building to suit the needs of committed customers. Speculative development will have to await better economic times. "I wouldn't say business is back," says Carver, "but there are a lot of people busy."
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