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KC Conway Zeroes In on the Big Story for Industrial

Connect Industrial Midwest 2023, scheduled for Feb. 22 at Joe’s Live in Rosemont, IL, promises to provide of wealth of insights from industry experts. First up will be the keynote speaker, KC Conway, founder of Red Shoe Economics, an independent economic forecasting and consulting firm that provides organic research initiatives, reporting and insights on the impact of economics within the commercial real estate industry. Connect CRE spoke with Conway for a preview of what he’s been seeing. 

Q: For the industrial sector, what are some of the key economic themes that people should be watching?  

A: One is that industrial remains a favored asset type. That didn’t change from last year. Iinstitutional money wants to rotate what it had in office into industrial. And the absorption numbers were very good in ‘22. CBRE’s year-end report looked at the top 100 leases. I think it was a record for the highest number of one-million-or-more-square-foot leases done last year. And the surprise markets were Southern California and Chicago. We’ve been thinking that everything’s been coming to the Southeast or Texas or Florida. But about 60% of the one-million-square-foot leases were in those two markets, Chicago and Southern California.  

The big story, not just for industrial but for all commercial real estate, is the capital lockup that we’re seeing, no matter what the property type is or what geography. What the Fed has done on interest rates is take the borrowing rate from something in the 3% to 4% range to now 7%. They want to get to a 5.5% and an 8% overnight borrowing rate. So what that means is the numbers just don’t work. I work with a lot of merchant developer clients and the biggest challenge you’re seeing is that their construction, land and outside development loans that they thought were committed by banks have all been re-underwritten or canceled. And so, just like that, a third of all development is stalled. It’s not because the demand isn’t there. It’s just that the cost of the capital is now so much higher.  

And so what’s happening is a lot of e-commerce and retail and warehousing clients that need space are saying, “We may not see much of this space come online the next year or two because of the capital lockup. And so we’re going to scramble and pick up everything that we can in the market.” 

Q: In a number of markets, the construction pipeline has been at almost record levels. And you’re saying that that’s going to taper off pretty pretty rapidly once it’s all spoken for.  

A: Yes, but I think it’s all because of the capital markets. So what I’ve seen is about 30% of everything that was ready to start here in the first half of 2023 has been stalled over a capital disruption. People want to take a pause here for three to six months and see where the Fed goes with this.  

We’re going to see a lot of creativity and innovation in how capital gets restructured or how it comes to make these industrial deals happen. One good example was just announced between Trammell Crow and CBRE Investment Management. It was a big deal in north Atlanta, up the I-85 corridor, 250-plus acres. They’re going forward with the closing of the landing site development for four finished sites, ready to start development two years out. And there was no leverage, no bank debt. So equity right now may be cheaper than debt. We always think of equity being more expensive, but there’s so much equity to be deployed and you’re looking for some kind of return. I think we’re going to see some interesting structures.  

I have a number of big retail e-commerce clients that realize what’s happening with the developers but need another million square feet. So maybe we take advantage of what happened two years ago with lease accounting, where leases had to go on the balance sheet of companies, whereas before they didn’t. There’s an incentive to own your own real estate. Several of them have been talking to me about taking some of the capital they’ve been putting into stock buybacks and putting that into self-developing their own e-commerce warehouses. The problem they have is they have no experience on how to manage a construction draw process. So they’re working with the merchant developers on how to solve that. It assures the stockholders that the capital is being properly allocated and deployed.  

Q: Have you previously seen a trend toward self-funded projects or is this new? 

A:  We see it in times when capital really locks up. We didn’t see so much between ’08 to ’10 because everything locked up. But you go back before that to the big debt crash or you go back to the 1980s, we saw some of this, but we’ve all forgotten it. Everybody that was in the industry then is aging out, and the new generation hasn’t seen a really good disruption, even if they’ve been in it for 10 years. So they think all of this is new.  

Also, we didn’t have the lease accounting rules 10 years ago. When retailers expanded, they did all of these leasing deals and didn’t care what the rent was until it didn’t make sense. They didn’t have to put it on their balance sheet, so it was a way to fund growth without having that liability on their balance sheet. Well, lease accounting really upended that for retail. And so now, for industrial, people are saying, “maybe that’s a possible solution here.” Because it’s illiquid, they can offload it, they can do a sale-leaseback or do something else after it’s developed. But right now they need to see that the pipeline gets finished.  

Q: Thanks, KC. Do you have some closing thoughts?  

A: Two things. I feel that remote work will be to office real estate values what e-commerce was to retail. And so you see that disruption to retail, you see it in office. So it favors multifamily and industrial. The 2023 ULI Emerging Trends report really highlighted that; every paragraph heading was incredibly bullish on the industrial sector.  

The second thing I would point out is that the ports are a really important story. L.A. and Long Beach lost their top position in container port activity to New York. You can’t blame union labor and all these other issues because both New York and California have the same issues. So New York pulled off something pretty well.

Also, the port of ports of Savannah and Charleston are on just an absolute tear. Savannah broke six million containers. They just got approval on Sunday to go to nine million containers within two years. That’ll put them on a level to beat New York and to surpass L.A., Long Beach. So the shift of the supply chain and of infrastructure is really underway. My theory has been that we’re moving our supply chain from West Coast to East, L.A. and Long Beach to Chicago, the East Coast to more north-south.

For more insights into the industrial market, be sure to register for Connect Industrial Midwest 2023, scheduled for Feb. 22 at Joe’s Live in Rosemont, IL. 


Inside The Story

Red Shoe Economics' Conway

About Paul Bubny

Paul Bubny serves as Senior Content Director for Connect Commercial Real Estate, a role to which he brings 13-plus years’ experience covering the commercial real estate industry and 30-plus years in business-to-business journalism. In this capacity, he oversees daily operations while also reporting on both local/regional markets and national trends, covering individual transactions across all property types, as well as delving into broader subject matter. He produces 15-20 daily news stories per day and works with the Connect team and clients to develop longer-form content, ranging from Q&As to thought-leadership pieces. Prior to joining Connect, Paul was Managing Editor for both Real Estate Forum and at American Lawyer Media, where he oversaw operations at both publications while also producing daily news and feature-length articles. His tenure in B2B publishing stretches back into the print era, and he has served as Editor in Chief on four national trade publications. Since 1999, Paul has volunteered as the newsletter editor of passenger rail advocacy groups (one national, one local).