The Inevitable Cooling, Even Under the Texas Sun

For the last decade, distribution and manufacturing warehouses have been one of the most consistent property sectors in all commercial real estate. However, that winning streak appears to be in peril as we enter the new year.

The Good

By every meaningful metric, Texas outpaced the economic growth of almost every other state in the country. While the blistering pace has since slowed after the historic boom in 2021, corporate relocations from other less business-friendly states continue. Texas gross domestic product (GDP) grew by 8.2% in Q3 2022, well above the national average according to the U.S. Bureau of Economic Analysis. The Texas Workforce Commission reported an unemployment rate less than 4.0% as of December, although that rate is expected to tick upward once the January statistics are released.

Inherently, more residents moving into the state means more goods and services will be consumed. This benefits every link of the supply/logistics chain.

The Dallas-Fort Worth area has millions of industrial square feet planned. The greater Houston area has single digit vacancy for existing space. Tesla® related suppliers around Austin are continually cropping up. San Antonio remains a price-friendly option for interstate industrial space.

The Bad

There is no denying that we are in the throes of a recession. The cost of goods has continued to climb at an unsustainable pace and various systemic issues from employment to the threat of a rail strike have plagued all business related to production and the timely delivery of goods. New hiring across almost every sector, including warehouse and manufacturing, is down.

According to CoSta, price growth for industrial properties cooled in Q3 2022, after the industrial index increased by just 1.9%. This is expected to shrink by the time the fourth quarter is reported.

Every major commercial real estate brokerage in the U.S. has announced cost cutbacks including, but not limited to, the reduction of employee headcount.

Amazon announced pulling back on more than two dozen projects in the pipeline nationwide as existing inventories are sitting longer than previously. Most of the space they are attempting to sublease is less than 100,000 square feet.

Seemingly right after the Duke Realty acquisition, Prologis took a similar stance on delaying new development projects.

Oil and gas projects are often project-specific, but that industry is also stalled until more clarity is given on the regulatory side. Incentives are being awarded to other alternative “clean” energies and technologies (as noted in the following section). The greater Midland area is capable of production, but only with more confidence from our governing bodies will significant capital be reinvested.

Ultimately, investor patience is being tested and the major retraction and continued volatility in the stock markets has necessitated a more measured approach going forward.

The Ugly

The cost of borrowing money is more than double what it was in Q1 2022. The repercussions of this are far-reaching and cannot be overstated.

In 2022, two noteworthy bipartisan acts were signed into law that were meant to spur investment, increase domestic manufacturing and slow the pace of inflation. The Inflation Reduction Act and the Creating Helpful Incentives to Produce Semiconductors Act. Each of these creates credits and incentives opportunities at both the state and federal levels when certain qualifying criteria are met. Given the abundant amount of federal stimulus for energy-related projects and existing and planned semiconductor facilities in Texas, this could eventually provide a future path for stability in the warehousing sector.

Traditional sales to institutional investors will slow as returns shrink and inherently cap rates are anticipated to creep upward. There will be a flight to quality and some of the mid- to low-tier assets will have extended marketing periods since projected rental growth is flatter than it has been in recent years.

Projects with tenants in tow with precommitments will proceed with caution while speculative projects, particularly of significant scale, will be on ice for the foreseeable future.

Summary

Texas is positioned better than many other states for the pending bumps in the road. Having said that, the days of endless capital investments and projected rental growth into perpetuity have dramatically slowed.

The first half of 2023 looks to be challenging with limited deals amid a cautious investment climate. The sky isn’t falling, but the clouds sure do look closer than they did one year ago.