Warehouse crunch is easing, but pullback will be modest

In our previous article we focused on the warehouse cost crunch facing the industry, with a specific focus on the fast-growing Inland Empire. Nearly six months later, we are revisiting this topic with another look at the industry; an outlook for 2023-2024; and guidance on preparing for a potential mild recession. 

The U.S. warehouse sector is still unquestionably overheated, but the market’s run of rent increases and tight supply appears to be cooling, with vacancies climbing modestly of late, according to Mohr Partners Commercial Real Estate analysis. As interest rates remain high, concerns about consumer optimism linger, and recession fears remaining front and center, retailers and suppliers will need to prepare to operate amid softening conditions. 

Murky economic picture

The overall economic picture is hard to read. Inflation has come down from its summer peak, but other price indicators – notably the CPI and PPI – came in hotter than expected in January. Despite headlines about workforce reductions in the tech industry, job markets remain abnormally strong. This strength, along with other factors, prompted the Federal Reserve to signal rate hikes to higher levels than previously anticipated. 

Consumer sentiment is as difficult to gauge. January retail sales increased 3% compared to December and were up 6.4% compared to the prior January, indicating spending levels are healthy. However, overall consumer spending did contract during the last two months of the year. 

Economists overwhelmingly expect a recession in the next 12 months, according to a recent Wall Street Journal survey. The degree to which the economy will slow, however, is up for debate.

Vacancies on a modest rise; rate increases slow

While vacancies remain near-historic lows, they have risen to 4.1% this quarter from the all-time nadir of 3.4% in the third quarter of 2022. Looking specifically at the Inland Empire region, vacancies hit a record time low of 1.1% in Q1 2022 and increased to 2.2% as of Q4 2022. There are still far fewer warehouses going unused in this region than in the country at large, but the uptick is nevertheless another sign of a softening environment.

The industry saw record completions in the fourth quarter of 134.5 million square feet, capping a full-year total of 445.8 million square feet in 2022. Rents are now at record highs, averaging $9.63 per square foot nationally and $17.64 per square foot in the Inland Empire. The rate of increases appear to be slowing, according to the January 2023 Logistics Manager’s Index .

This could mean a potential normalization is on the horizon.  

Capacity to remain scarce

Normalization, however, does not equal a market collapse; a major pricing pullback isn’t likely in the cards.

Mohr Partners analysis shows that while overall demand is showing signs of softening, the bulk of the impact has been in spaces 300K SF and less. Demand for big box space is still high and construction of new inventory has slowed.

While certain retailers – including Amazon – have pared back capacity, not everyone is following suit. This is partially due to a widespread industry transition from just-in-time inventory models to just-in-case. The pandemic taught many businesses that the cost of spare capacity can be offset by the ability to take advantage of opportunities in the marketplace.    

Another trend to watch is the rate of near-shoring and re-shoring taking place in recent years. As manufacturing increasingly locates closer to end users, it is spurring demand for warehouses, logistics hubs, and distribution centers. 

The outlook for 2023-2024

Market participants looking for a significant spike in capacity or pricing relief are going to be challenged. Inventory will remain tight, and rents will continue to rise. 

Prologis is predicting new warehouse development starts could fall to a seven year low in 2024, a result of a forecasted 60% decline in 2024 vs. 2023. This could lead to shortages of new space in the future and potentially an increase in rent rate growth.

While mild recession could hamper short term demand, the reshoring trend could fuel the longer-term demand trajectory. 

Preparing for a downturn

The U.S. warehouse market is still hot going into the middle of 2023, but there are signs of softening demand on the horizon. The U.S. economy could be heading to a recession within the next 12 months, so preparing and developing contingency plans are critical. Here are seven steps to take ahead of a potential recession:

1. Make the most of your space with creative solutions 
2. Trim labor costs by investing in automation
3. Do more with less. Take a serious look at productivity per employee
4. Aggressively negotiate for price breaks and volume commitments with suppliers
5. Develop a comprehensive picture of your inventory 
6. Develop contingency plans if some of your suppliers get into trouble
7. Renegotiate your leases now. If you signed a lease any time before mid-2021, your lease rate will likely not be lower in the foreseeable future. As long as rents continue to rise, locking in rental terms for as long as you can confidently forecast the need for space is a prudent approach