Monthly Archives: July 2008

The New Language of Industrial Real Estate and Its Pitfalls

 

Over the past 20 years, the decision matrix for locating a warehouse has grown so complicated that only a few real estate brokers have the ability to communicate on a technical level with clients.  Many warehouse companies require labor studies, network rationalization models, transportation studies, and warehouse design.  Many large brokerage companies have complied by starting practice groups within their firms or have hired talent outside to provide these services. Professionals that talk this new language are generally at the forefront of controlling the relationship. 

One major pitfall to this analytical approach to site selection has arisen.  There was no accounting for high fuel prices.  Many companies located distribution facilities on the fringes in order to get large, bulk warehouses that were regionally central, but far away from population densities.  Now, with the advent of high fuel prices, traffic congestion, and sustainability issues, some of these decisions are fraught with unexpected, and even, out-of-control costs.  In many cases, anticipated savings from operational efficiencies and cheaper rents are being vastly eroded by high oil prices.

In a previous business cycle, manufacturers made location decisions a different way. They picked locations based on proximity to major customers, suppliers, and labor. The benefits were easily recognized with quicker deliveries and more personal interaction.  For instance, if you were in the aircraft business, you would locate near the primary contractor so you could easily supply Northrop, Douglas, or Hughes.  In addition, the social relationship helped suppliers refine their components to more closely meet the needs of the customer. This explains why Southern California became a hub of aircraft and defense manufacturing. This same trend is noticeable when foreign car plants are situated in Southern or Midwestern states. There is a follow on trend with many suppliers moving close to the final assembly plant. This logic creates clusters for more efficient production. In contrast, the trade route dynamic places warehouses almost anywhere, as long as there is a major road.

Many leaders in the logistics industry have a global level perspective that measures international traffic on an hourly basis. Working backwards from delivery times,   concepts such as intermodal, inland ports, and supply chain have riveted the industry. Shipping patterns from Asia to domestic ports have captured the imagination of developers and brokers alike. Many major developer/owners have made significant investments in large land tracts and buildings in the hinterlands to take advantage of supplying product as fast as possible.

The result is larger warehouses, lots of loading, and land to park trucks.  In order to find large sites, warehouse construction has moved far away from the urban core to the periphery and into neighboring states.  More profoundly, what once housed the U.S. defense industry, now serves Southern California as inland ports and warehouse centers.

All of a sudden, high fuel prices, traffic congestion, and poor consumer sentiment have made many of these distant locations very expensive to operate.  Compare Tesco’s new warehouse in Moreno Valley to Safeway’s presence in El Monte or Albertson’s new Paramount location.  Look at 99 Cents Stores’ warehouse in their ancient but centrally located buildings. Central warehouse locations are now a competitive advantage to keep prices low. It’s completely opposite to what many consultants recommended in their views of efficiency.  Today the cost of fuel to inland ports could easily be two to three times more than the monthly rent of a brand new building in central Los Angeles.

New intermodal inland ports have to address other concerns in the way of transportation costs.  Since these locations are normally located far from the harbor, the combination of rail, plane, and truck should provide superior transportation amenities.  However there are hurdles.  With the exorbitant cost of trucking, oligopolistic rail lines will increase their rates to gain additional revenue into the expanding margin.  Besides many of the rail links still don’t exist from key short haul routes like the Alameda Corridor.  Air has limited applications except for dedicated providers.  The majority of air freight still comes in the belly of passenger planes through LAX and is transferred to truck.  DHL’s flight reductions to March Air Force Base is one example how a major dedicated provider can put the entire model in jeopardy.

Despite the intermodal amenities, the main reason companies look at inland port locations is because of cheap land and labor.  While intermodal can be important in some cases, it is often a marketing tactic to sell more dirt. But fuel costs are making these locations look very expensive.

Labor may also be a surprise.  Many companies try to locate where there is non-union labor.  But because of the Clean Trucks Program slated to be adopted by the Ports of Los Angeles and Long Beach, an interesting wrinkle has surfaced.  The Teamsters have allied with the Green community to reduce pollution in the Harbor area.  By removing independent and arguably illegal operators from the road, smog can be reduced by greening larger carriers. While years of litigation will be the next step, many companies are not looking forward to union deliveries, no matter how far away they locate.

One more current sweeping the industry is sustainability. For now, a lot of focus is on managing LEED buildings to be carbon neutral.  For factories, the emphasis is on limiting emissions through a variety of trading and control mechanisms.  For trucking and warehousing, sustainability will be measured by fuel efficiency. Many customers are picking service providers from the perspective of good stewardship and cost saving.  Deadheading to far flung warehouses will be a highly negative factor compared to a coordinated central location.

This is not say premium rents are being enjoyed in central locations. For now rents are decreasing because of the general business malaise and a pull back from over optimistic times.  Still over the next few years, if there is no relief in fuel prices, many businesses will look at central locations differently.  Many developers are considering multi-story warehousing as a way to overcome high land prices.   Roof top truck parking will pay for expensive infill land. Other developers are tearing down portions of their buildings to provide better trucking and truck parking. As has been proved in other cases, the underlying land can be worth more than the marginal value of older buildings and teardowns will continue.

As total operation costs become aligned with rent, higher infill pricing will look reasonable even for low clear warehouses.  New concepts will first be tried as a build-to-suit for progressive companies looking to promote image and save costs. If they prove successful, the value of infill locations will further increase.  Soon, the language that placed warehouses on the outskirts will add some new vocabulary to drive these companies back to the center.

SIDEBAR:

THE FUTURE OF GODDS MOVEMENT

The movement of goods throughout Southern California has been endlessly studied by government and quasi government agencies.  One overriding solution is to develop a major inland port at one of the former air force bases in the Inland Empire. It will cost billions of dollars and is many years away. Plus it’s not a practical solution for goods returning to Los Angeles. To see some of the ideas proposed, go to http://www.scag.ca.gov/goodsmove/   

A more immediate solution is to get Los Angeles cities to adapt zoning regulations to allow more distribution space by increasing height and FAR limits. Other cities need to re-examine their unreasonable ban on warehouse and distribution uses. This effort can be coupled with a floor or gross receipts tax to pay for infrastructure costs.  For municipalities, warehouse jobs and added revenue will replace loses from retail and housing.

Certain parts of Los Angeles could serve as a testing ground.  Big swaths of industrial in Rancho Dominguez, East L.A., Goodyear Tract, or Broadway/Rosecrans could accommodate these changes without disrupting residents.  Until there is a concerted effort, developers and users will continue to fight the battle on a project-by-project basis, while pushing perceived negative impacts farther down the road.