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IRE Adapts to Economic Change

Although there may be bumps in the road ahead, industrial real estate appears to be poised for a healthy future over the next year.

IRE has been booming since before the Covid 19 pandemic began in 2020, which then give it a shot in the arm from widespread lockdowns that fueled the expansion of ecommerce, especially when it came to a wide range of consumer goods, placing a greater emphasis on last-mile home deliveries.

Warehouse growth also has been shaped by the supply chain crisis, including freight railroads’ major service deterioration, the persistent truck driver shortage and continuing port congestion. The result has been an emphasis on building safety stocks, particularly in the retail sector.

“News of overstocked stores and warehouses has dominated recent headlines which, on the surface, could be concerning,” says Prologis Research. To better understand what is really going on the researchers took a deeper dive to probe the data to find the implications regarding logistics what’s happening to real estate demand in the U.S.

The Prologis Research. conclusions are:

  • Inventories have grown but are far from calibrated for sales or resilience. In the wake of the pandemic, logistics users need 800 million square feet (MSF) or more to accommodate anticipated inventory growth.
  • Wide variation exists by store type and product category. Retailers that benefited from strong sales and had the resources to order extra
    goods are now above pre-pandemic benchmarks for inventories relative to sales. Others, however, have not yet recovered. Specifically, general merchandise stores have an inventory-to-sales ratio that is 15% greater than it was in 2019. To better understand this number’s context, keep in mind that the ratio for all other retailers is -8% below, Prologis says.
    For all retailers, excluding auto, the inventory to-sales ratio was 1.16 in May, which was 5% below 2019’s average of 1.22.
  • Historic supply chain lead times amplify risks from changing consumer behavior. Prologis expects volatility to last well into 2023, which will make it more challenging to secure the right size inventory that can respond to real-time shifts in consumer preferences.
  • Safety stock remains in focus; cyclical momentum will impact the timeline. In the event of a softening economic landscape, the researchers say they would expect a pause in planning and implementation until economic volatility subsides.

“Prologis Research maintains our call for the inventory-to-sales ratio to stabilize 5-10% above pre-pandemic levels, adding resilience to supply chains and generating the need for 800 MSF of more space in the wake of the pandemic,” the researchers said in their analysis.

Of course, coming to these conclusions depends on how you choose to look at the available data.

For example, nominal inventories are amplified by high inflation and a volatile auto sector. As a result, Prologis excludes autos (which reside on lots, not in warehouses), and adjust for the Producer Price Index (PPI), and calibrate for demographics

Another important consideration that must be taken into account is that these inventory increases are relatively new. In the last six months, they’re up 7% on a net basis for both wholesale and retail industries, the researchers point out.

Prologis says that its proprietary IBITM Survey has shown that utilization of warehouse space rose to 85.6% as of June 2022 but remains below a functional ceiling in the 86-87% range. Further inventory build should necessitate additional logistics real estate, the company concludes.

Are Inventories Too Low?

Nominal retailer inventories (excluding auto) are up 26%, while retail sales are up 33%, leaving the May inventory-to-sales ratio 5% below 2019 levels.

Sentiment indicates that inventories are too low, the researchers argue. “Customers remain focused on building inventory, reducing stock outs, and reintroducing product variety.”

Even as inventory levels have risen, the researchers  reveal that remarks appearing in companies’ earnings call transcripts routinely note the following: “in-stock position not back”; “focused on carrying more product”; “continue to improve the supply chain”; and “customer service starts with being in-stock.”

Taking the broad view, the Prologis researchers also took a look at executives’ views about inventory levels. Sentiment was found to be significantly below 50 as of June of this year, pointing to a real need for more robust inventories.

“Given recent progress in building inventories, this could also reflect not having the right inventory for today’s demand trends,” Prologis suggests.

For all retailers, excluding auto, the inventory to-sales ratio was 1.16 in May, –5% below 2019’s average of 1.22. However, data reveals that general merchandise stores have an inventory-to-sales ratio 15% greater than in 2019. Excluding this category, the ratio for all other retailers is -8% below 2019

Analysis of available public commentary being expressed by retailers suggests am inventory to-sales ratio mismatch concentrated in products related to housing (furniture electronics and appliances), the researchers explain.

Housing has faced recent headwinds because of consumers’ desire to get out of the market and rapidly rising interest rates that also dampen home sales. “This suggests the problem may be isolated to certain companies and product lines versus being a widespread issue,” the researchers believe.

“Persistently long supply chain lead times could alter consumer behavior,” they add. “Consumer preferences in this regard have never changed as dramatically as what we have now.”

At the same time, ocean transit times were more than double pre-pandemic levels, and sentiment on deliveries and shortages reveals ongoing stress on supply chains.

Conditions are improving, but reliability is not yet a given (and may remain elusive through the longer term). Prologis also reaffirms its belief that supply chain volatility will extend into 2023.

Resilient inventories are still the goal. Comparisons are tough in this unique environment of the past two and a half years, and since then business and consumer sentiment has yoyoed up and down.

Inventory growth has been rapid — a natural response to persistent stock-outs, unreliable supply chains and rapidly rising prices.

“Yet, pandemic-driven scarcity (and related pricing power for retailers) was unsustainable and, ultimately, we have anticipated a return to the imperfect inventories and resulting discounts of pre-pandemic times,” the researchers conclude.

However, the end goal is the same: Logistics customers planning for the long-term are building the capacity to shield their businesses from disruption; cyclical momentum will determine the speed of this build-out.

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