How Transport’s 'Rule of 1.5' Is Driving Soaring Demand for Warehouse Space

The US industrial market is on pace for a record leasing volume with activity through July reaching 587 million square feet – 52 percent more than the year-earlier period, according to a new report from CBRE. 

Sharply higher transportation costs – which are rising faster than rental rates – is helping to fuel this robust leasing activity.

The spike in transportation costs – across sea, land and air – is the result of backlogs at ports, rising fuel prices and increased strong consumer demand driven by e-commerce growth and the pandemic’s continued effects. 

For example, the cost of shipping a 40-foot container by sea from Shanghai to the Port of Los Angeles is up 235 percent from this time last year, according to Drewry Supply Chain Advisors.

To hedge against further rising costs, companies have expanded domestic warehouse space to reduce the frequency of long-distance shipping.

And it’s more than that. The so-called “Rule of 1.5,” is playing out today, according to Adam Roth, a director of NAI Global Logistics at NAI Hiffman.

“I’ve learned over the last 25 years that when something happens in transportation, trucking and retail, it will hit industrial a year-and-a-half later,” Roth said.

In other words, events from a year-and-a-half ago are influencing industrial now. Transportation costs, for instance, are the biggest dictator in site selection for distribution facilities. 

“The commercial real estate costs are just a rounding error,” he said.

In December 2017, regulations were passed requiring truck drivers to log their hours into an electronic logging device that made it difficult to fudge their hours. 

“That took 8% to 10% out of the capacity of truck drivers, which in turn impacted the haul costs to distributors,” Roth said. “There are two ways to offset the length of the haul. One is modal transport, the other is having more real estate. And real estate costs are a lot lower than transport costs.”

Today the rule of 1.5 is still in play. Factors that will influence demand over the next 18 months include insurance costs, which are really squeezing the trucking industry at the month and the growing unreliability of the international supply line, Roth says.

“As the international supply chain becomes more expensive and unreliable, domestic manufacturing becomes more competitive,” he said. “All of this bodes extremely well for industrial real estate and absorption.”

Choosing to Pay Higher Warehousing Rents

According to CBRE’s Supply Chain Advisory, transportation costs can account for 50 percent to 70 percent of a US company’s total logistics spend. Fixed facility costs, including real estate, comprise only 3 percent to 6 percent.

“It takes roughly an 8 percent increase in fixed facility costs to equate a 1 percent increase in transportation costs,” said Joe Dunlap, managing director of CBRE’s Supply Chain Advisory. “The increased real estate costs pale in comparison to what they are experiencing with transportation costs. They are calculating that it is better to pay higher rents if they can lower transportation costs with a strategic occupancy plan.”

This year’s robust leasing activity has driven the national warehouse vacancy rate down to 4.0 percent, which, in turn, has catalyzed a 9.7 percent jump in first-year rental rates.

Logistics Companies’ Appetite for Warehouse Space Not Waning

Third-party logistics (3PL) providers have benefited from the exponential growth in transportation costs because more occupiers have responded by outsourcing distribution and warehousing. As a result, 3PLs have leased 121 million square feet of bulk (100,000 square feet and above) industrial space, representing a 31.3 percent market share. This is nearly double the 66.8 million square feet (24.5 percent) 3PLs leased in the same period last year.

“Local markets are all feeling the pinch as costs are increasing and lead times for material deliveries have certainly increased,” said Glynn Mireles, first vice president with CBRE Industrial Services in Houston. “In Houston, a shipping container cost last year was around $5,000; now, the cost is $20,000-plus per unit container. Our industrial brokerage team expects to see the demand for warehouse space to continue, especially from 3PL fulfillment companies. The reason is that their customers are loading up inventories when products are available to avoid dealing with long lead times and rising transportation cost.”

Retailers and manufacturers are increasingly reliant on the market expertise of 3PLs to help them navigate significant supply chain challenges, John Morris, executive managing director and leader of CBRE’s Americas Industrial & Logistics business, said. “As a result, 3PLs’ robust appetite for warehouse space shows no sign of waning.”