By Taylor Williams
Architects and general contractors are shaking up the ways in which they design and construct industrial projects in response to financial pressures faced by their clients, an elevated emphasis on sustainability and shifts in how tenants utilize spaces.
The nuts and bolts of designing and developing commercial properties are fickle by nature, as they are beholden to consumer preferences, which are in a perpetual state of flux. Yet the current shifts in industrial design and construction practices should not be viewed as indicators of the sector’s waning popularity among investors.
“Despite a difficult rate environment that is causing challenges for all sectors of the economy, we have deep optimism about the near- and long-term future for the industrial market in New Jersey and Pennsylvania,” says David Greek, managing partner at regional firm Greek Real Estate Partners. “This region sits amid the most densely populated area in the nation and continues to grow. At the same time, the consumer shift to e-commerce is not nearly complete, creating a dramatic long-term need for logistics facilities to accommodate this historic change.”
In other words, industrial is still hot. And the most visible and basic change occurring within the property type — a move toward smaller facilities — does not mean that land prices for industrial sites have crashed or that tenant demand has shrunk. It’s merely a short-term evolution based on major headwinds — take a bow, interest rates — that impact all asset classes in all markets.
Further, the general downsizing of industrial projects is a natural progression within urban districts in the Northeast, which tend to be tight on land, time-consuming on approvals and permitting and costly on actual construction.
Getting Smaller
At this point in the cycle, the collective impact of 11 interest rate hikes totaling 500-plus basis points is difficult to overstate. Yet, as a rule, tenant demand for industrial space remains quite diverse, robust and seemingly sustainable in the long run. Lenders and investors still have a healthy appetite for these deals and projects.
Enter simplicity of economics. Smaller projects inherently require fewer capital inputs — land, labor, construction materials — than their larger counterparts. Less principal is required to finance their construction. And when interest on said principle is five times what it was 18 months ago, and there’s precious little wiggle-room on debt pricing, lenders and investors will look for ways to cut their initial capital outlays.
“For the past five or more years, large new logistics spaces have attracted the lion’s share of interest in the Northeast market. However, there is now a growing focus on smaller existing industrial spaces among investors,” says Greek.
“Historically, smaller spaces demanded higher rental rates per square foot due to the greater cost necessary to build and operate these facilities,” he continues. “That trend flipped when the demand for large, new, state-of-the-art logistics space exploded with a dramatic rise of e-commerce. Very few smaller industrial spaces have been built in the past decade, and demand remains high, especially for higher-quality warehouses. Rental rates are expected to push much higher over the next several years, making smaller facilities an attractive investment.”
A parallel within the push for smaller industrial projects is a shift away from speculative projects and toward build-to-suits. Once again, larger macroeconomic forces bear responsibility — in this case, the growth of nearshoring and U.S. manufacturing operations. Many tenant requirements in the market today are tied to vendors and suppliers that support mega-users with huge production facilities. The underlying business models of many of these deals tend to be very precise in terms of spatial requirements.
“We are seeing more demand for smaller facilities closer to major metropolitan areas and, in some instances, closer to larger projects to support larger manufacturing and fulfillment facilities for unique material fabrication or supply,” says David Michael, vice president of sales at Peak Construction, an Illinois-based general contractor that is active in the Northeast. “Smaller facilities are being developed for very heavily populated urban locations to optimize the growing demand for immediate delivery, as well as for feeder locations near larger projects.”
“Due to the current climate of rate hikes and accessibility of capital, many companies have turned away from speculative projects,” says Jeff O’Neill, principal and managing partner at metro Boston-based Polar Design Build. “Finding capital for a build-to-suit or a speculative project that has some leasing in hand has created a more favorable environment for construction lending. In other words, the local climate calls for smaller footprints or subdivisions in larger designs.”
Michael further believes that within the tight urban areas of the Northeast, which are renown for high land prices, more vertical industrial development is inevitable. This will be especially applicable to e-commerce and last-mile delivery users. Both of these groups tend to require a lot of car and truck parking, and with limited land to work with, users will increasingly consider adjacent or other offsite parking structures to fulfill this requirement, Michael says.
For the bevy of industrial tenants that have businesses tied to servicing manufacturers, proximity to the mother facility is paramount. That means that real estate professionals serving those clients are increasingly looking for repositioning opportunities in well-located buildings that are older or were developed with other uses in mind.
“With the ever-increasing demand for the R&D components of a company to be close or co-located with the manufacturing component, what few buildings and parcels are left to develop or reposition into quality industrial/flex spaces should be viewed as opportunities,” notes Alvaro Ribeiro, senior architect at Boston-based design firm Margulies Perruzzi. “This is especially true in markets like Boston, where land is at a premium.”
Uniquely Specialized
The high degree of specialized requirements that exists among today’s industrial users is a testament to the ongoing evolution and elevated sophistication among Americans and the products they consume. For industrial architects and contractors, it means no two projects are the same — unlike when huge speculative facilities are dropped into giant fields along the side of a highway.
“Traditionally, the mention of the words ‘industrial real estate’ conjures up images of plain, big-box warehouses with a spartan, ‘function before form’ approach to design where racking capacity and quantity of loading docks are the sole measures of success,” says Ribeiro. “While these metrics are certainly important, they are only part of the overall success.”
“Increasingly today, the tenant makeup in the market for industrial and flex space consists of advanced technology and research and development users for which there is often no precedent to measure against,” he continues. “Many of these tenants have highly specialized manufacturing processes that are themselves continuing to evolve, making every project a unique prototype.”
Derek D’Amico, associate principal and partner at Margulies Perruzzi, offers anecdotal evidence of just how unique and highly specialized industrial projects can be in this day and age. The project in question involves a 62,500-square-foot addition to an existing 367,873-square-foot warehouse in Southboro, Massachusetts.
“It’s an extension of Westfalia automated crane pick system to add over 9,000 additional pallet positions to the system that we helped install in the existing building in 2017,” D’Amico explains. “There was also an extension of the existing cooler system, adding 8,000 square feet of [air] conditioned space. What makes it unique is the primary program is space for the automated system and racking, so the systems are all minimal.”
“The intent is to maximize the number of pallets that can be stored, as each represents a profit for the client,” he continues. “On the existing warehouse, this involved evaluation and installation of additional structural and mechanical elements since the building wasn’t originally designed for this kind of structural load and system. The challenge was getting the new addition to fit within the strict tolerances of the system.”
Eco-Friendly Mindset
Industrial users are notorious for requiring huge amounts of power to operate their facilities. That feature alone automatically complicates efforts to reduce carbon footprints, but architects and contractors are finding creative ways to offset that challenge, often at their clients’ behest.
“We are currently fielding requests for features like solar panels, back-up generators for power and reduced-carbon concrete, and all of our developer clients face similar types of challenges to achieving the goals they set for their projects,” says Michael. “The implications of these challenges, if not addressed, can have an extraordinary impact on the overall success of the project and the business for which the project was conceived.”
Above all else, prevailing trends and practices in industrial design or construction tend to stick when they save money. But if they can do some good for the environment in the process, so much the better. The emergence of tilt-wall construction as the primary approach to ground-up industrial projects illustrates this dual threat in action.
“In the past, warehouse buildings were constructed with metal panels, which were often damaged from forklifts and other distribution activities,” explains Mike Kunz, principal and owner at Massachusetts-based Maugel DeStefano Architects. “In tilt-up panel construction, the concrete contractor pours the walls within the building, and then a crane is used to lift the walls in place, ensuring a higher degree of durability efficiency, sustainability and cost-effectiveness. Tilt-up panels also have much smaller carbon footprints than metal panels.”
In the context of sustainability, parking is once again a symbol of change. Heavier reliance on electric vehicles (EVs) is a key means of promoting sustainability, both for consumers and businesses. E-commerce and logistics users are increasingly employing these types of trucks and vans within their fleets. Developing the electrical infrastructure in parking areas to support this initiative is thus an important consideration.
“With the country’s push for renewable energy, EV chargers are in high demand in all sectors, including industrial,” says O’Neill, who also cites the growing prevalence of solar rooftops as a symbol of eco-friendly change. “Due to the heightened need for the charging stations, any location that can offer this will offer a leg up on their competition for attracting tenants and potential consumers.”
Give Tenants What They Want
In the world of commercial design and development, “flexibility” is a word that has a perpetually positive connotation. By definition, the term inherently recognizes the fact that user whims and preferences are constantly changing and that facilities should be designed and constructed to accommodate those changes. Industrial projects are no exception.
“Most developers and users are looking for flexibility in industrial buildings,” says Kunz. “A flex building is designed to be easily customized to a client’s needs, whether that be office, warehouse, distribution, manufacturing or multi-tenant [divisibility].”
Labor is also a crucial piece of the industrial operations puzzle. When tenants tour potential sites, they often do so with an eye for their employees’ comfort and well-being. Architects and contractors are taking note, according to Ribeiro.
“There is currently an increased emphasis on branding presence and better-quality main building entries and facades in industrial buildings,” he says. “Since many of these advanced technology companies are growing, they conduct frequent tours of their facilities to would-be investors, and the arrival and entry points are the first chances to make lasting impressions of a well-organized, fluidly operating company. These tenants are frequently competing for the best talent, and a quality workplace goes a long way with recruiting.”
As industrial real estate has experienced major growth over the last decade, a subcategory known as “industrial flex” has emerged and proven to be quite popular among investors and users. The label is typically applied to facilities that have an above-average component of office space to complement the manufacturing, warehousing and distribution. And since — unlike their peers in pure-play office settings — industrial workers must be onsite to do their jobs, office space is an increasingly important consideration.
“The trend is to initially design the building to accommodate small office spaces before a tenant has landed, but also to make it flexible enough to be enlarged once a tenant has been signed,” explains Kunz. “To ensure that a developer can attract the widest range of potential tenants, the design should consider multiple entrances, flexible ceiling heights and the ability to easily add a floor.”
Kunz also cites column spacing as a critical design requirement that is changing to accommodate today’s wide range of industrial users.
“If you think about Amazon or Wayfair, a customer can purchase a pen or a couch — two very different sized items that need to be stored and accessed efficiently,” he postulates. “The flexibility of a building’s racking system and its ability to handle a range of inventory is therefore very important. If you increase the building’s column bay spacing, you can increase the size of stored goods.”