Feeling the squeeze, Part 3: Warehouse storage

Disruption has gone from buzzword to everyday reality for wholesale distributors in recent years. From manufacturer shortages to port delays to the prohibitively priced freight market, distributors have been saddled with challenges across the supply chain. 

These challenges have become incredibly disruptive to one of the core tenets of distribution: warehousing. As demand for warehouse space has exploded, we have witnessed the most competitive market for warehouse storage in recent memory. 

How did we get here?

Over the past two years, demand for e-commerce sales was accelerated by the pandemic. In fact, in 2020, e-commerce sales increased 25% year over year, amounting to 16% of all retail sales. With this positive demand shock, distributors across industries had to carry more inventory to meet new e-commerce demand. To further complicate this, distributors were also met with unprecedented levels of supply chain disruption, resulting in supply uncertainty. Just as we saw in the case of automotive parts distributors, wholesalers were mitigating supply uncertainty by shifting the inventory paradigm from just in time to just in case. The concurrent demand and supply shocks saw wholesale distributors maintaining higher inventories to keep up with demand.  

This influx of inventory sent shock waves into the industrial real estate market as distributors and retailers alike engaged in a race to support current warehousing demand and build capacity to support speculative future demand. No single company built a bigger warehouse war chest than Amazon as its fulfillment center footprint more than doubled, adding over 200 million square feet in storage space between 2020 and 2022. While Amazon may have made the fastest advancements, distributors large and small aimed to grow their storage footprint. 

In Q1 2022, a meager 4.2% of the US warehouses sat vacant, a 27-year low. With waning inventory, average warehouse rents increased 11.8% overall with even higher spikes in top markets like New Jersey. 

Distributors turned to hedging a challenging rental market by building speculative future capacity. Industrial developers experienced record growth in new warehouse construction. As of Q1 2022, about 750 million square feet of new warehouse space is in development, up 50% from 2021. 

With disruption affecting both demand and supply for warehousing storage, it begs the question is there any relief in sight?

What has changed?

We have seen several signals that the industrial real estate market may begin cooling in quarters ahead. 

On the demand side, the pandemic growth in e-commerce has experienced a correction as e-commerce sales as a percentage of total retail sales fell from 16% to 14%. Additionally, consumer sentiment is shaky as inflationary pressures mount. Despite these consumer signals, any relief in warehouse availability will lag consumer demand given the distributor’s role in the supply chain. In fact, distributors’ inventory positions may actually increase in the interim as retailers are likely to change ordering behavior to accommodate slower consumer demand. 

On the supply side, distributors and developers who raced to build sufficient warehouse capacity on reaction and speculation have now been saddled with excess capacity and even more in development. After two years of rapid expansion, Amazon has announced the decision to slow the growth of its distribution network. Amazon CFO Brian Olsavsky noted that Amazon is happy with their decisions to expand to accommodate demand over the past years, but grateful for “a chance to right-size our capacity to a more normalized demand pattern.” Amazon is reportedly seeking to exit between 10-30 million square feet of warehouse capacity by subletting and seeking early lease terminations with their REIT partners. 

What does this mean moving forward?

With the shifting market dynamics, distributors are once again met with the uncertainty of exactly where the market is headed. While there are some unmistakable signs of a cooling market, it’s impossible to fully understand when and to what extent warehouse vacancy rates and rents may begin to normalize.

There are several opportunities for distributors to continue to be as efficient and effective as possible while prudently letting the market evolve. These are: 

• Current footprint evaluation: It’s paramount for distributors to have a strong understanding of their current distribution footprint as it relates to their stocking decisions, service level, and customer geography. With additional warehouse capacity coming online via sublets or lease terminations, there may be select opportunities for distributors to secure additional capacity at a discount in an underserved market or consolidate multiple distribution nodes. However, these decisions are best when supported by a careful analysis of the entire distribution footprint and capacity requirements. 
• Improved 4-walls effectiveness: Distributors in need of additional warehouse storage capacity may be able to find it within their existing footprint by practicing good warehouse operations hygiene. As we discussed, inventory levels may rise in the interim; distributors can accommodate the increase by evaluating and reducing the slow-moving and obsolete (SLOB) inventory within the network through promotional discounting and scrapping. Similarly, distributors can improve storage density and free up space by improving warehouse slotting or even investing in higher density storage solutions.
• Proactive capacity and capital planning: Surging customer demand during the pandemic forced distributors to be reactive if they were to meet the new demand. As the market potentially cools, distributors should be more forward-looking in planning the future of their distribution network. While current capacity may not be a concern for some distributors, it may still be the right time to plan and build additional capacity in the coming years with the understanding that new developments may take as long as three years. By taking a purposeful, proactive approach to capacity and capital, distributors will be better positioned to accommodate future demand without scrambling to the rental market. 

With the only certainty for distributors being more uncertainty, it’s imperative to take full advantage of the current distribution network by maximizing effectiveness until a clearer understanding of the industrial real estate market emerges.