By Richard Gorodesky, SIOR, senior managing director, Colliers International; and Adam Gorodesky, associate, Colliers International
Commercial real estate is historically a cyclical business. There is a fairly predictable pattern of oversupply, recession, recovery and finally expansion before starting all over again. While the cycle isn’t always this cleanly defined, it generally follows this pattern, and has done so for decades.
While this formula can be very useful for understanding the cycles and what occurs during them, it lacks one key ingredient: timing. There’s no way to accurately predict when one stage is ending or how long each phase will last.
On a basic level, like in all markets, the commercial real estate market cycle responds to the balance, imbalance and rebalancing of supply and demand. The factors that influence the market and determine the length of each cycle are and will continue to be moving targets.
Richard Gorodesky, Colliers International
Demand Overview
While e-commerce represents about 18 percent of retail sales today, and it is widely believed in commercial real estate circles that that number could grow to 30 percent by 2025.
Amazon, online retailers and other e-commerce companies have not only fueled demand for last-mile distribution facilities, which are necessary to reach as many people in as short a time as possible, but also created a shortage of space for nearly all categories of industrial users. Building supplies, commodities, refrigerated and frozen food, corrugated box manufacturing and scores of other non-e-commerce users are also feeling the pinch, leading to higher rental rates and sale prices.
“Last mile” has been a popular term for the last few years, but now we are even hearing talk about the “last 100 feet.” This is a particularly critical concept in urban locations such as Philadelphia where narrow streets and population density provide challenging delivery obstacles.
Owing in large part to supply chain difficulties in the early months of COVID-19, the “just in time” method of production scheduling, which had been popularized as a greater means of manufacturing and warehousing efficiency, is being phased out in many circles and replaced with a “just in case” approach. The disruption of the global supply chain has proven to be extremely expensive to multiple groups throughout the network.
Adam Gorodesky, Colliers International
It’s common for ports to be constrained for land near the docks, and Philadelphia is certainly no exception. Our Packer Avenue Marine terminal is expanding via an inland site with economic help from both PhilaPort and the State of Pennsylvania.
Once this additional warehouse space is delivered next year, it will allow the port to demolish the older warehouse and expand its container laydown yard capacity. Of course, more containers will lead to more demand for additional inland warehouse space as well. Developers know this and are responding accordingly.
It seems that all sources of real estate debt and equity capital are demanding some level of placement in industrial product. When this level of investment demand from capital sources occurs, existing buildings are snatched up and rental rates rise, it eventually leads to more development, as new projects are underwritten and approved to be constructed.
Supply Situation
The greater Philadelphia region has about 350 million square feet of industrial space; of that, about 280 million sits along the desirable I-95 corridor and Southern New Jersey (which we define as below Exit 8A).
We have surveyed these corridors and are tracking nearly 25 million square feet of new industrial space that will be completed over the next two or so years. That will be almost a 9 percent increase over the current level of supply. But this new inventory will only absorb some of the demand.
These new buildings will mostly feature clear heights of 36 to 40 feet, or higher in some cases. This is perfect for regional e-commerce sortation and delivery centers, but the greater height does nothing for other users. For example, commodities such as raw cocoa beans — about 80 percent of the cocoa that comes into the United States comes through Philadelphia — cannot utilize that height using its existing storage patterns. This will put pressure on these users to adapt.
Looking beyond the next two years, there is at least another 30 million square feet of development proposed between the Hilco site in South Philadelphia and the Keystone Trade site in Bucks County.
As we are seeing with Hilco’s 1,300-acre site in South Philadelphia, remediation and site work projects can be done to adaptively repurpose older legacy industrial sites into bustling warehouse and distribution complexes. And the urban core location of the Crown 95 Logistics center will be re-imagined as a 381,000-square-foot distribution center on 19 acres of unreplaceable inner city land.
As these and other projects get redeveloped and leased, at some point developable land parcels will run out or become too expensive, creating a natural cap on the total amount of new construction that can be added to the market.
Besides natural barriers, developers are often hampered by the entitlement process. In some areas, local residents’ opposition to increased truck traffic, noise and hours of operation are beginning to fuel opposition to some “by right” projects. In addition to land constraints and entitlement issues, developers are often at the mercy of construction costs, many of which are experiencing rapid rises in pricing and longer lead times for delivery.
Conclusion
What does it all mean for the near future of Philadelphia’s industrial market? Although history has taught us that no single phase of the cycle lasts forever, at least for now, demand is showing no signs of slowing down. For the next few years, we believe that these newly approved projects will be leased before they are substantially completed.
We all know that this unparalleled growth in the market will not last forever. But due to the fundamental shifts in consumer purchasing preferences and the aforementioned constraints on supply, we believe that it would take a transformative change to alter the path of this robust market.