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How a Mangled Supply Chain Led to an Industrial Real Estate Renaissance

Despite President Biden’s casual announcement that the COVID-19 pandemic has come to an end, the industrial real estate sector is still reeling from the virus’ impact. Bubbling geopolitical tensions, a mangled supply chain, and sky-high inflation continues to affect the market and for valuations of industrial properties. This is particularly true when it comes to properties that support the manufacturing sector. 

The COVID-19 pandemic was so monumentally disruptive that manufacturing companies are clamoring to pull back their operations overseas and bring them closer to home. Whether it’s by way of re-shoring (where companies bring back their manufacturing services from overseas to their country of origin), or nearshoring (where businesses transfer work to regions geographically closer to their base of operations). Either way, industrial real estate is getting a reset after a decades-long trend of pushing manufacturing jobs overseas.

Bright promises and foggy data

America began its life as a titan of manufacturing, but by the early 1970s, manufacturers began outsourcing a sizable portion of their production to countries with less expensive workforces, like China. The allure of offshoring was so palpable that the McKinsey Global Institute touted it as a “win-win situation for the global economy” back in 2003. Yet over the past few years, the overreliance on offshoring began to show cracks. 

As offshoring sharply increased in the 1990s, the American manufacturing sector employed more workers than any other sector in most U.S. states. Many of those jobs were lost to foreign competition. 

U.S. manufacturing employment dropped from 16 million workers in 1993 to a little over 10 million by 2010 | Source: Centre for Economic Policy Research

It’s incredibly difficult to pin down the extent of the effects manufacturing plant closures had on commercial real estate values in the corresponding area. The direct impact offshoring had on American jobs is a good place to get an idea, but even that data is hard to come by. Even the Congressional Research Service struggled to find the exact answer in 2012. “The only regularly collected statistics on jobs lost to the out-of-country relocation of work come from the U.S. Bureau of Labor Statistics’ (BLS) series on extended mass layoffs,” the congressional report reads. The BLS series also couldn’t provide a clear answer because the data pool was extremely limited. “Since 2004, BLS has asked firms with at least 50 employees that let go of at least 50 workers in layoffs that lasted 31 or more days whether the firms moved the laid-off workers’ jobs out of the United States. Given the series’ exclusion of small companies and focus on large layoffs, it underestimates the number of jobs lost to offshoring.” 

Even today, the U.S. still does not track the amount of jobs lost to offshoring. At most, the U.S. Department of Labor keeps count of the number of workers who petition for Trade Readjustment Allowances, or support payments for individuals who cited job loss as a result of foreign imports (after they’ve already exhausted their unemployment compensation). What we do know is that during Barack Obama’s second term as President, 209,735 petitions for trade allowances were filed. Despite vowing to keep manufacturing jobs on U.S. soil when he was ushered into the Oval Office, Donald Trump’s administration saw just slight improvement with 202,151 petitions.

Even with murky hard data, the loss of American jobs to offshoring was a grievance aired in the political arena, and from the communities affected, it’s easy to see why. Not only did these layoffs damage U.S. workers, they also hurt entire local economies, causing mass exodus in some cases. From a real estate perspective, total community dismantling is not exactly a good omen for business.

And then, of course, COVID happened. 

Traumatic supply chain injury

The pivot to offshoring in the name of fast-paced growth and profit left the manufacturing sector incredibly vulnerable to a global pandemic, showing that the model of greater distance comes with greater risk. Due to its long-standing reliance on manufacturers in Asia, American manufacturing became overly dependent on imports, which completely backfired as the global supply chain spiraled out of control and crippled what remained of the domestic supply chain.

Results of the U.S. Census Small Business Pulse survey. From May 31-June 6, 2021, 36 percent of small businesses reported delays with domestic suppliers | Source: Whitehouse.gov

“COVID was a wake-up call,” said CNBC commentator and former hedge-fund manager Ron Isana during the National Association of Realtors C5 Summit. “We’re seeing companies move from a just-in-time model to a just-in-case model.” Isana is certainly not alone in the opinion that supply chain vulnerability casts offshoring in a harsh light. The National Association of Manufacturers, the largest manufacturing association in the United States, recently released their Third Quarter 2022 Outlook Survey which showed damning evidence that supply chain issues will continue to plague manufacturers even after the threat of the COVID-19 virus has been mitigated. It’s clear that the global supply chain exposed market inefficiencies, but savvy commercial real estate professionals know how to exploit market inefficiencies to their benefit.

Tactical reshoring

Brewster Smith, Senior Vice President of Supply Chain Solutions at Colliers, told me that the COVID-19 outbreak brought home to American manufacturers the hazards faced by offshore business ventures and how dependent they are on the global supply chain to get their goods back to domestic markets. “The supply chain disruption of 2021 taught us that our national supply chain is too dependent on manufacturing capacity in one part of the world that is too far away,” he said. “Re-shoring will help regionalize and/or localize the availability of supply for critical goods that will restore our supply chain resiliency.”

Agreeing with Smith, many companies are either planning to, or have already, recalibrated their operations by transferring their operations that had been moved overseas back to their home base, also known as re-shoring. Last year, more than 1,800 companies re-shored their productions, according to a report from the Reshoring Initiative, a non-profit organization dedicated to reigniting the manufacturing business in the U.S. Businesses want to expand or move their facilities more quickly and with less capital outlay than in the past, evident in the record spike in companies looking to pull their business back.

Smith maintains that the businesses which manufacture commoditized goods will remain overseas, but businesses that churn out goods with intricate production processes (which require a skilled labor force) are more likely to yank productions back. After all, shorter supply chains streamline demand data, improve the efficiency of inventory data, and ultimately improve order reaction times. 

But even after the massive reckoning from the global supply chain’s downfall, total re-shoring is not exactly viable for a lot of industries that really would benefit from having their operations much closer to home. The use of foreign manufacturing can be a huge liability for the U.S. drug supply. Pharmaceutical drug manufacturers are not able to pick up and return so easily. Even though prescription drugs and medical devices are highly complex products that require an exceptionally skilled labor force to make them, re-shoring pharmaceutical manufacturing is an endeavor of extremely high costs because biopharmaceutical facilities are subject to hyper-specific regulatory requirements. But even so, there is a strong case for pharmaceutical manufacturers and other industries where re-shoring is too cost prohibitive to reevaluate the local manufacturing strategy and figure out how to improve supply chain resilience and control exogenous vulnerability. The answer? Nearshoring.

Nearshoring to you

Nearshoring and re-shoring are similar concepts that involve businesses positioning their operations closer to the point-of-sale, but nearshoring is the compromise between offshoring and sourcing a local team. The idea behind nearshoring is simple: while maintaining the advantages of being in, say, the U.S., some functions are moved to accessible regions which have lower operational costs, like Mexico. A nearshoring location must have affordable property occupancy costs, adequate transportation connections to the capital and other important business hubs, and a competent labor pool. When compared to a pure reshoring strategy, nearshoring can yield more favorable results, primarily because supply and production risk can be diversified, partners with specialized skills and knowledge can be chosen to complement existing capabilities, and businesses can benefit from more favorable tax and regulatory structures while more clarity is still lacking in the U.S., as CBRE is seeing in Monterrey, Mexico.

Repurposing existing facilities for manufacturing has drawn a lot more interest from manufacturers. The companies of manufacturers are likewise seeing more upheaval and disruption. Additionally, if manufacturing facility sizes shrink, so may the amount of investment and dedication. As a result, leasing can be seen as having a smaller risk than in the past.

Barbi Reuter, CEO of Cushman and Wakefield, believes that nearshoring is the answer to a lot of industrial woes as nearshoring improves supply chain predictability and reliability while maintaining more advantageous labor access and costs. “There is a desire from employers and manufacturers to manage the downside and improve their supply chains and operations,” she said. Between mitigating supply-chain challenges, overcoming reshoring’s difficulties without sacrificing its advantages, and presenting a more favorable labor-cost environment, Reuter insists that “[nearshoring] is going to remain strong for the foreseeable future.”

The mangled supply chain put re-shoring and nearshoring in the spotlight, but is recalibrating the manufacturing sector closer to home as much of an economic win-win as offshoring was once said to be? Well, not exactly. 

Companies flocked to offshoring for years because of the cost-savings, and nearshoring is inevitably more expensive. If we look at it from the perspective of an American corporation, they would nearshore to either Canada or Mexico. Even if it may be less expensive than employing Silicon Valley professionals, this still costs more than recruiting developers from India or China. Companies are also more geographically limited when they opt to nearshore their operations, which could hinder better business partner relations. Advocates who are vying for manufacturing to return to the U.S. for the sake of American jobs aren’t getting their prayers answered, which means that nearshoring is not reinvigorating the real estate markets that the offshore wave of previous decades left behind. Nevertheless, re-shoring and foreign direct investment targeted at specific locations by way of nearshoring are both contributing to the robust recovery of U.S. manufacturing. Even with inflation at a four-decade high and interest rates continuing to rise in the background, investment in industrial real estate has soared. Plante Moran’s U.S. Industrial Real Estate Market Summary of last quarter showed that the sector is experiencing both record-low vacancy rates and record-high rent rates. 

With manufacturers shifting to a more robust supply chain management strategy after the pandemic unveiled a flawed system, industrial real estate in North America is experiencing a sudden rebound. After years of the sector being an overshadowed asset class, much in thanks to the offshoring surge of the previous decades, industrial real estate is having its renaissance moment.

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