Changes within the warehousing and distribution model
By Daniel P. Leahy, SIORNAI Hiffman/NAI Global Logistics
The warehousing and distribution industry is taking bold steps to respond to the changing economic and business circumstances we have experienced over the last several months. Demands to reduce overcapacity, improve speed from source to shelf, satisfy concerned stakeholders and comply with emerging regulations are being met with fundamental operational changes. These changes include the increased use of intermodal, maximizing information technology, green warehousing, and logistics outsourcing.
According to Commerce Department figures, retail sales improved 2.7% in August compared to a decline of 0.2% in July. It is too early to say that we are out of this downturn; however ocean trade, a key market indicator, is also making some positive traction. According to the monthly Port Tracker report by the National Retail Federation and IHS Global Insight, U.S. ports handled 1.04 million TEUs (20-foot equivalent units) in May 2009, the most recent month for which data is available. This is a 5% increase from April but down 20% from April 2008. The forecast for the first half of 2009 is 6.5 million TEUs, compared with 7.5 million that passed through the first half of 2008. While these improvements are promising, the economic recovery has a long way to go and will need to build strength through job gains, rising consumer confidence, improved housing market and retail sales in order to turn the tide.
For real estate practitioners, the silver lining during these tough times is discovering the new companies, business operations, trade lanes and industries that are emerging.
The recession has forced many warehousing and logistics companies to streamline operations and reduce costs. Research studies have demonstrated that superior environmental performance leads to positive financial results, including higher returns on assets. The return on such investments increases considerably as the cost of fuel rises, which it will as the economy recovers. Companies are increasingly formalizing their environmental sustainability programs to demonstrate their commitment to protection of the environment to concerned stakeholders and customers. A recent study found that more than half of Fortune 500 companies have a formal sustainability program and issue a sustainability report to stakeholders on an annual basis. Warehousing and transportation organizations are participating in voluntary programs to satisfy mandatory requirements such as EPA Climate Leaders, EPA SmartWay Transport Partnership and the U.S. Green Building Council’s LEED certification program. The LEED certification requirements include energy savings, water efficiency, CO2 emissions reduction and indoor environmental quality. As we build warehouses and develop business parks, these will be key components for tenants when considering where to locate.
Understanding who has the financial capacity combined with a strong business plan to occupy industrial space within the market is critical. The U.S. third-party logistics industry is showing surprising resilience in this downtown and appears to be the most active tenant for years to come. According to Armstrong & Associates, net revenue for 3PLs that provide domestic transportation and warehouse services is down only 2.5%. Transportation management and warehousing and related value-added services are most common services for the 3PL segment, accounting for 60% of the total 3PL market.
The bright spot for 3PLs has been the volume of new business from first time users of 3PL services. These users are focusing on their core competencies and cutting costs. New and existing customers are looking to 3PLs not only to lower operating costs but also help them remove assets from their balance sheets. Customers are asking 3PLs not only to operate their warehouses but to determine which products to put in them and how much inventory to hold. They want support for postponement strategies that bring finished goods as close as possible to demand points, and fine tune service levels for optimal pricing. These customer demands will in turn put demands on landlords as they look for very favorable terms and pricing. It is our opinion for years to come that the outsourced model will continue to grow and lease rates will continue to be very aggressive with shorter terms. This structure will put significant pressure on financing buildings for the significant future.
As businesses grow more attuned to benchmarking total landed logistics costs and evaluating supply chain performance, transportation costs continue to be scrutinized. On average, transportation represents six to eight times the cost of rent within the logistics cost model. With the current economic conditions, more corporations are focusing on transportation cost reduction. This is greatly impacting how companies view rail. Intermodal interest, drayage calculations, as well as how both of these impact a supply chain’s CO2 emissions have all become discussion points for companies considering locating on campus at an intermodal center. Confidence in intermodal growth is seen in commitments from both CenterPoint Properties and the Union Pacific Railroad with the new Joliet Intermodal Terminal that is under construction and planned to open in June 2010.
With transportation volumes being down overall, these conditions have led to major increases in vacancy rates and declines in lease rates in the vast majority of industrial markets as of the 2nd Quarter 2009, compared to twelve months prior. The good news is that with signs of economic recovery, retail bankruptcies and tenant defaults will slow down, if not end. As inventories are replenished and manufacturing increases, the industrial markets will experience positive absorption over the coming quarters. Because little to no new construction is underway, a strengthening economy will help the industrial real estate market rebound more quickly than for office and other real estate segments.
Daniel P. Leahy, SIOR, is executive vice president, NAI Hiffman, and managing director, NAI Global Logistics.