Industrial Growth: Too much, Too Little or Just Right?

Article originally posted on AZ Big Media on October 13, 2021

Greater Phoenix has earned a reputation as an attractive place for industrial developers thanks to a business-friendly environment, well-built infrastructure and the region’s proximity to trade ports in California. These are some of the factors that led Taiwan Semiconductor Manufacturing Company (TSMC) to build a $12 billion chip plant in North Phoenix and Intel to spend $20 billion expanding its operations in Chandler. 

“We’re in the 11th year of a very strong industrial market, and we just posted the 45th consecutive quarter of positive net absorption,” explains Pat Devine, senior vice president of the U.S. region for Artis REIT.

While industrial growth is a boost to the region, there can be too much of a good thing. Does the Valley have a glut of development? Not enough? Or, as Goldilocks says, is it just right?

COVID-19 Growth

During the onset of the pandemic, people around the nation hoarded supplies, and headlines concerning the lack of toilet paper were in nearly every newspaper. Prior to the crisis, many companies depended on just-in-time inventories, which meant most locations only kept the bare minimum supply of product on hand before the next shipment arrived. While this corporate model is efficient, some businesses are rethinking the need for having more inventory at the ready in stores in order to be prepared for potential crises.

“We’ve seen a change in supply chain strategies from just-in-time to just-in-case to hedge against disruptions in a user’s supply chain, which leads to the need for more warehouse space,” Devine says.

The vulnerability of global supply chains caused businesses to reassess how materials are sourced.

“Companies realized how susceptible they were to international trade when they stopped having access to things that were exclusively produced overseas, which halted certain processes and productions. I think people started immediately looking at ways to mitigate that risk, which for us, luckily, means more domestic manufacturing,” comments Nic Fischer, investment officer at Merit Partners.

Bringing manufacturing processes back to the U.S. is becoming more common, with Southern California being a prime destination. Greater Phoenix, however, benefits from the increased competition for limited industrial real estate west of the Colorado River.

“There’s a trickle-down effect from the Southern California market because manufacturers are leasing space and taking buildings that other industrial users no longer can occupy,” notes Cooper Fratt, senior vice president at CBRE. He points to the current semiconductor chip shortage as an example of how onshoring has benefited the Valley.

The massive investments from TSMC and Intel are drawing other businesses to the region. “In the market today, we’re tracking more than 20 companies that are locating here purely to serve either TSMC and/or Intel as part of their construction and expansion, as well as in their future operations. We’re seeing that those chip companies are bringing many more businesses and employees to the Valley than you read about in the headlines,” Fratt continues.

Another factor exacerbating the need for warehouse space is the rise of e-commerce during the pandemic. Folks who wanted to limit physical contact with others looked to online retailers to deliver products to their front door.

“There was a flight to online retail from a segment of people who, for whatever reason, were not participating prior to the outbreak but were then somewhat forced to because of limited access to brick-and-mortar retail,” says Fischer.

Amazon is at the top of the heap when it comes to e-commerce, but other traditional retailers are competing for market share.

“Wayfair, Best Buy, Home Depot: What were typically your big box retail stores are now establishing an e-commerce presence in places such as Arizona and other population centers that can support it,” notes Robert Guerena, managing partner at GO Industrial. “For example, Walmart just took down 1.2 million square feet along Loop 303 and Glendale Avenue.” He contends that the increase in demand from online shopping factored into Walmart’s decision-making.

Public safety measures complicated restaurant dining, and many turned to meal prep delivery services, such as Blue Apron, Gobble and Freshly, for dinner. “These food supply chain-related entities had to rethink how they were working and distributing their products,” Fischer comments, adding that such services also increased demand for more warehouse space.

Guerena continues, “HelloFresh just leased 440,000 square feet at the Prologis Logistics Center IV. We’ve seen it across all retail types: food, consumables, luxury, furniture — the whole gamut. Everything continues to migrate toward e-commerce, and the pandemic spurred that acceleration.”

Goldilocks Ratio

Even before the COVID-19 crisis changed the commercial landscape, Greater Phoenix was a destination for industrial users. In the northwest region, facilities such as Cives Corporation’s steel fabrication plant in El Mirage dot the landscape. In Gilbert, aerospace and defense company Northrop Grumman recently expanded its satellite manufacturing facility by 220,000 square feet. There’s no doubt that industrial development is taking place throughout the Valley, but is there too much or not enough — or is it growing at a sustainable pace?

One key measure of a market’s health is vacancy rates. Too high of a percentage can signal undesirability to investors, whereas too low of a number means fierce competition and potentially higher costs for whatever space is available.

“Since 2009, our base has grown from 272 million square feet to 345 million square feet, while net absorption during the same time period was almost 95 million square feet. That’s how your vacancy rate drops from almost 15% in 2010 to less than 6% today,” Devine comments.

When looking at how much industrial space is being occupied, context is crucial to understanding what constitutes a healthy rate. Southern California’s proximity to trade ports make the region desirable for industrial users of all kinds who are willing to pay a premium.

“Vacancy rates mean something different in every market,” Fratt explains. “In certain parts of Southern California, they’re less than 1%, which is low. At the end of the first quarter, Greater Phoenix’s vacancy rate was 5.58%. If you look back historically, that’s the second lowest we’ve had in the last 20 years.”

According to Guerena, the current vacancy rate in the Valley is healthy, but it could change. “It’s something to keep an eye on as new developers and new competition come into the marketplace and search tenant sites that may not fit the mold for a logistically convenient location,” he says. “But for core locations, such as in the heart of the Loop 303 and the southwest Valley, there are very few options for people to tour.”

Fischer agrees, adding that the market is seeing historically low vacancy rates paired with record high under-construction numbers, which means anything that is being built is quickly absorbed. “You could probably argue that we’re a little underserved,” he says. “I’ve heard recently about users coming to our market and wanting to see five or six different options, but there’s only two or three good choices — and those are being looked at by other users at the same time.”

“In order for Greater Phoenix to continue attracting these industrial companies and all the jobs that they bring, we need to have options,” Fratt argues. “In my opinion, the 5% to 6% vacancy range that we’ve been in for that for the past several years is a very healthy number. It allows us to have readily available buildings that companies can occupy when they come to tour. But it’s also not such a big vacancy that deters developers from continuing to build in the Valley.”

Growth Runway

Anyone who has lived in Maricopa County for a few years has witnessed the rapid expansion taking place. But development cannot continue unimpeded forever.

“As you look at how far out becomes reasonable for Valley residents, we’ve proven that people don’t mind the sprawl, but I think some of those habits might be changing,” Fischer says. “Are we going to run out of good land that people want to occupy? If we can stay ahead of the curve with good infrastructure, I think that we’ve got a lot of opportunity in front of us. If we as a development community and as a state don’t want to make those investments, we could run into an issue where we don’t have a whole lot of available land.”

Guerena believes that land constraints aren’t as big of a roadblock as labor shortages. “As we continue to add large e-commerce and distribution centers, where are the employees that can fill those centers and perform the tasks the company needs coming from? I think that’s the biggest question that employers are starting to ask themselves. It’s not just about the logistic location, but it’s where the employees are.”

Fratt concludes, “I think the industrial growth that we’re seeing throughout the country — not all of it, but some — was due to the pandemic and its effects. Along with the business-friendly environment that we have in our state, I think those two factors combined give Greater Phoenix a three-to-five-year runway for industrial development at minimum.”

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