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The Supply Chain Crisis and Commercial Real Estate

The pandemic caused a ripple across global supply chains that isn’t quite finished yet. The early 2020 shock of factory shutdowns across China which caused sudden ramifications in the supply chain has transitioned into a supply chain crisis with production and the long supply chain faltering under the weight of a number of convoluted economic and social factors.

Not many areas of life or business have gone untouched by disruptions in supply chain and commercial real estate is no different; whether it’s industrial, office or retail property, the effects of stop-start supply and demand in globalized economies will be felt way into the New Year and beyond.

Supply Chain Disruption and Industrial Demand

Changing Inventory Management Models

COVID-19 exposed just how fragile the supply chain actually is for many companies running a Just-in-Time (JIT) inventory strategy. JIT supply chains rely on a very lean system of keeping just enough inventory to cover immediate, short-term customer demand which is a strategy that’s been preferred by big corporations since the 1970s to ensure working capital is optimized and wastage minimized.

This served most businesses well prior to the pandemic, but since the initial outbreak, these lean ways of working have been derailed and companies scrambled to move back to traditional supply chain management using a Just-in-Case (JIC) approach. This approach meant reverting to ordering inventory ahead of time and having it sit on the shelves just in case it’s needed using estimates of anticipated demand. Although the JIC method ties up cash in inventory that could otherwise be deployed elsewhere, it means that companies are less susceptible to sudden supply fluctuations and can still meet customer expectations.

As a result of these pivots in supply chain planning, it’s estimated that inventories may grow between 5 and 10%, the question is, where is all that additional stock going to go?

Transportation Costs Outpace Everything Else

Further accelerating demand in the industrial sector is the composition of business costs related to the supply chain. Transport costs are the biggest proportion of a business’ expenses and faced with the choice of moving further away from consumers and transport hubs, companies are instead more than willing to pay the increase in rent to get into a better location. Industrial rental rates are growing massively with the Toronto Regional Real Estate Board (TRREB) reporting an 18.4% increase year-on-year for the Q3 period. Whilst not an insignificant increase by any means, these costs still lag way behind transportation and labor which are growing at a much faster rate and businesses can substantially reduce their outgoings by securing a site in an optimal location, closer to large urban centers.

What are the Implications on Commercial Real Estate?

On every level, each issue affecting the supply chain points to increased demand for industrial space - warehousing, fulfillment and distribution centers are all in huge demand and despite an increase in properties under construction (13% increase in warehouse construction starts for the full year 2020), space is rapidly running out and supply chain disruptions are both friend and adversary to real estate at the same time.

With vacancy rates in Ontario at an all-time low of about 1.6% and tenant demand forcing both existing stock and land prices upwards, the challenge is keeping up with insatiable demand for bigger and better industrial properties in ideal locations.

Tenants don’t just want more space for their growing inventory either, they want diversified offerings from their facilities, including;

  • Close proximity to a quality labor market;

  • Buildings that attract labor through convenience and modern and appealing design features;

  • Future-proofed with ESG features to reduce energy consumption and waste and improve quality of life for the occupants;

  • Accommodations for the implementation of new technologies as organizations ramp up automation and digitalization to improve efficiencies;

  • Access to additional parking and truck space for seasonality.

In a very tight market, even when construction gets underway, the commercial real estate industry, like every other, is experiencing escalating costs; costs for raw materials, energy, freight and new technologies are inevitably hurting the bottom line. Delayed materials crucial to completing in-demand projects are also creating headaches for developers and tenants alike, many of whom have committed to leases pre-completion.

New Year, No Let-Up in Industrial Demand

The supply chain crisis shows no signs of abating until late 2022 and real estate will be playing catch-up long after the pandemic truly dissipates. Demand in the industrial sector will continue to be healthy and competition for both property and land fierce for at least the next few years. As land is scarce and marred with zoning difficulties, the industry will need to find alternatives for this burgeoning market.

Faced with reaching capacity in industrial stock, suburban and and out-own-town satellite warehouses and distribution centers could well be needed to bridge a gap, perhaps on a more flexible and short-term basis than prior. Existing properties may also need clever re-purposing to improve the meager ceiling heights found in warehouses of the 80s, making way for multi-level deliveries, picking and packing and more power for new automated equipment and processes.

Land to building ratios will also need to balance to accommodate larger truck and parking areas which are limited in older properties. In these respects, there really is nowhere off-limits for new warehouse builds and nothing to impede growth aside from a lack of vision.

Companies looking to expand need to plan ahead and investors need to be on the lookout for properties that can endure change or existing stock with potential to meet the needs of the supply chain of the future. There’s one word that sums up the supply chain of 2022 - nimble.

Contact Private Capital Group to explore your options in the industrial market in the GTA.

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