California construction activity has limped along at a lackluster pace since the Great Recession, with one bright exception: the industrial sector. That strength was the focus of commercial real estate lobby NAIOP’s Inland Empire chapter’s recent annual market review.
Even as employment returns to pre-recession levels across the economy, demand for business space has lagged. Absorption rates for office and retail space in California is well below levels seen prior to 2007 despite a near-total recovery of lost jobs, according to analysis presented by Beacon Economics.
Meanwhile, industrial job growth has been disappointing on its face — especially manufacturing. And yet, despite what appears to be a struggling sector, industrial vacancy rates are some of the lowest around. Of the 110 million square feet of industrial space that has come online since 2005, 109 million square feet has been absorbed, according to Bill Heim of Lee & Associates.
So why the disconnect? If commercial and retail employment is stronger than industrial growth, why is demand for industrial space outpacing that of offices and stores?
The changing industrial equation
Boosters argue it’s the way of the future.
Evolving technology is changing the way each of these industries operates, reducing the need for office space and keeping retail vacancies high. Even as consumer spending rebounds and job growth continues apace, businesses just don’t need the kind of room they used to.
Meanwhile, the gap between industrial productivity and employment growth grows wider as manufacturers and suppliers figure out how to produce more output with fewer workers. Sophisticated automation and management on the warehouse and factory floor yield fewer industrial jobs even while the sector expands.
Those shifts form a feedback loop: rapid growth in e-commerce, for example, decreases the need for brick-and-mortar retail outlets while creating demand for state-of-the-art warehousing and distribution space, driving industrial development.
That’s bad news, right? Not necessarily. While industrial jobs may be declining in quantity they are improving in quality. According to Beacon analysts, average annual logistics sector wages top $40,000 in California, beating out average wages across the larger private sector.
That might not be glamorous pay, but those solid middle-class wages have real spillover effects for local and regional economies. It’s the virtuous economic cycle at work. Well-paying jobs create consumers who spend on all kinds of services and goods — including homes. In turn, those businesses expand in response and bolster demand for industrial and commercial space.
Built to last?
Of course a few grains of salt are in order when reports on the health of an industry come from its primary cheerleaders. Conference presenters cited the vast sea of capital searching for a shore in industrial real estate, and right now the winds are strong.
But with the current pace of growth — the Inland Empire alone saw 16 million square feet of industrial construction as of Q1 2014 — a shift in the tides presents the risk of a glut.
And all that hot money looking for a home in industrial development will turn instantly cold when short-term interest rates rise as they’re expected to do in the next year, sure to send speculative investors for the hills.
Even Beacon’s economists were measured in their enthusiasm for industrial growth. Careful to emphasize that logistics and warehousing development is a great “right now” strategy for the Inland Empire, they stressed that it’s not the only future for the region struggling region, considered a leader in the logistics sector.
Temperate prognoses aside, industrial job growth still carries the torch that lights the way out of our economic doldrums. The next time you’re tempted to look askance at warehouse development, remember that everything else — commerce, services, education, healthcare and even real estate — falls in line eventually.