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Episode #8 - 2020 Predictions with K.C. Conway

Episode Summary

The Industrial Advisors sit down with K.C. Conway, Chief Economist for CCIM Institute, to discuss their predictions for the commercial and industrial real estate market in 2020 and beyond.

Episode Transcript

Bill Condon: Welcome everybody to our 2020 predictions podcast. It's a pleasure to have joining us today. K.C. Conway. K.C. is the CCIM Institute Chief Economist and is also the Director of Research and Corporate Engagement at the Alabama Center for Real Estate housed within the University of Alabama's Overhouse College of Commerce. K.C. is a frequent speaker for the federal reserve, the FDIC, frequently with state bank commissioners, academic groups, professional organizations and a lot of real estate industry associations. K.C. previously worked at Colliers International. He was the Chief Economist where we did a lot of work with K.C. so we know firsthand how knowledgeable and how great he is with research and so K.C., it's great to have you here with us. Thank you for taking the time. We're looking forward to a great session.

Matt McGregor: Welcome K.C..

K.C. Conway: Great, thank you. And happy new year on our first crazy Monday of the year. Right?

Matt McGregor: That's right. K.C., maybe we'll just kick it off. 2020 predictions. What are the two kind of biggest impacts on distribution and fulfillment in the United States that you see coming online for this year?

K.C. Conway: Sure. I can't just give you two. I may give you three or four real quick, but I'd say the first one is I'm actually more bullish. We've got, looks like a China trade deal. Phase one at least we'll quit throwing rocks at each other. We're going to do that in the Middle East instead. Number two, we get USMCA over the goal line. So that's phenomenal for us, I think industrial and distribution. So those make me very optimistic. Third is, I think Boeing is a really big deal. We're going to learn a lot about supply chain and all the intricacies of Boeing, which is our largest US exporter to the world. So I think Boeing is a really big deal. And my last one is that industrial properties will remain the favorite asset class again in 2020. Green Street Advisors, their year end commercial property price index showed it was up again on average another 12% last year. That's double what multifamily was. So even though we got 300 million square feet underway, don't worry about it. We need a billion square feet with all the stores that are closing.

Matt McGregor: That's right. And you mentioned Boeing, obviously a huge story nationally as well as internationally, but we're from Seattle here, so they're right in our backyard. What is your thoughts on Boeing for this year?

K.C. Conway: So I think all the hopes that the thing will be resolved in the first quarter are very optimistic and this thing's going to drag on. Gosh, it's almost a lesson in how to mismanage kind of a crisis and getting the information out, and annoying your regulator. Kind of reminds me of being in the Federal Reserve, we used to tell banks what not to do to make us upset so we wouldn't close them, but they would never listen. So the thing is people don't realize Boeing just doesn't make everything in one or two locations. GE makes the engines, is a huge impact in places like Wichita. Interiors are made somewhere else. It's intricate all over the place. It's not just there in Seattle, think of South Carolina and the Boeing plant down there. And there really is no substitute for the 737 MAX. There's the bigger airplanes and the Airbus has got bigger equipment. So it's a big deal and it's going to impact supply chain in a different way as much as the tariffs did. We learned a lesson about supply chain through the tariffs.

Matt McGregor: And speaking of tariffs, K.C., you had mentioned that because of the scarcity of the tariffs that the 2019 inventories were kind of spiked with three PL's and they didn't hit their numbers in the fourth quarter. What's your thoughts on that now with the latest trade war news?

K.C. Conway: So all is good. I think the whole USMCA thing, we just have to keep Trump off Twitter as it relates to Canada and Mexico and 2020 will be very good. But I'm not really as worried about it. I think in supply chain, one of the things we've learned is that, this kind of the old days when I was going through business school and just in time inventory is a big new thing is maybe not the best strategy, and that you need to have redundancy and build up. So I think folks have kind of swung the other way with the pendulum and that we build up inventory a little bit more. There's lots that can disrupt supply chain. And so I'm not worried about the inventory side.

Bill Condon: And K.C., Matt talked about Boeing. Let's talk about another company that's in our backyard. Amazon, they continue to lease space across the country for fulfillment, for last mile. How do you view Amazon and do you think there's companies out there that are going to be competing with them in 2020? What's your take on that?

K.C. Conway: Yeah, so it's a good question. So I believe that Amazon in this next decade will go through a similar situation as AT&T did in the 1980s. They're going to be broken up. They're getting too big. They have tentacles in too many directions. They're just a huge monster. Went from books and musics and the largest apparel and everything else. But here's where I'd give some solace. Number one, they can't come close to touching Walmart. Walmart is still the biggest retailer in the world. They're the gorilla. They have not only figured out e-commerce and fulfillment and last mile, but they've got the stores, the touch point with everybody to order online and pick up fulfillment. I think it's something like 85 or 90% of Americans live within half an hour of a Walmart store, which is phenomenal on that side. So Walmart is behemoth.

K.C. Conway: The other thing that we've learned is that Amazon has forgotten that it's not a good thing to eat your young, they devour their customers. So I'll give you a great example from this last year. So I'm the red shoe economists. So Amazon was upset that Allbirds sell their shoes on Amazon. And so they had a perfect red shoe, a red shoe economist. So here's my new crimson red ones. So they wouldn't sell them to them. So Amazon went and found a vendor to substitute manufacture it, cut the price in half and try to put Allbirds out of business. Well, companies like Target and others have realized that maybe the best way to deal with Amazon is to get a divorce. And so if you look at Walmart, you look at Target, you look at FedEx, there are more entities that are divorcing from Amazon because they devour their business.

K.C. Conway: And it's kind of like doing business with China. If you do business with them, but then they devour you and cheat, it's not a good business model. And I think Amazon is kind of in that thought realm today by the major retailers. I worry they're very distracted and people forget Amazon can fail and stumble. Last year after spending hundreds of millions of dollars trying to get into the casual dining delivery and compete with Uber eats and everybody, they abandoned, they bailed out. So Amazon isn't infallible. They're very distracted. They've got tentacles everywhere. Heck, they couldn't even get HQ2 right. Right? They picked two cities [inaudible 00:07:09] then they go back into New York. They can't even figure out where their headquarters is going to be.

Matt McGregor: Great point. K.C., next question. I come and watch you every year. Love your predictions.

Matt McGregor: You've talked a lot in years past about autonomous vehicles, autonomous trucks, and I know we've seen some of that in California. You mentioned it in Florida. What's going on with autonomous trucks? How is it going to change distribution and fulfillment moving forward? And is it going to be relevant sooner than later?

K.C. Conway: Yeah, no, super question. So all I would say is autonomous trucking is not a future event. It is here today. So January 1, 2020 Florida became the first state in which autonomous trucking was legal, insurable, and feasible statewide on every US, state, and federal interstate system. Summer of last year they passed all the legislation including liability insurance and everything else to make it feasible. Basically the model they've adapted, I kind of correlate it to an air traffic control system. There's a company that's actually based out of the West coast called Starsky that developed the technology and the center, when someone wants to deploy an autonomous truck say from Miami to go up to the Lakeland, Florida, it will be registered with an autonomous truck control center.

K.C. Conway: There'll be a controller that will have control elements of the truck that will follow it all the way to his point of deployment. That's real today. The next state I think that's really got a jump on it is Texas, between Texas and Arizona. Even the postal service has been doing test pilots with autonomous trucks between Phoenix and Dallas and here are the things that I think that are important to note about it. Number one, it's I think a phenomenal thing because it will remove a lot of truck congestion during the day and peak hours on our highways and commuting time and put them in at night, and even bad weather, because autonomous trucks don't mind driving at night. They don't need to stop and go to the bathroom. They don't need a cup of coffee. They don't complain and they don't mind driving in snow or rain.

K.C. Conway: So we can now put these trucks into higher utilization at times that we didn't when we had a human truck driver. Number two is many of these trucks now are designed to run on compressed natural gas. So they are cleaner, they have a sleeve that goes onto the top of the tractor trailer that connects into the engine and fuels the truck. So that's pretty neat on that side. And I think the third implication is how we think about the design and the land to building ratio for future big e-commerce warehouses where these trucks are going to be coming in and out of is going to change tremendously.

K.C. Conway: You've got underway in Seattle, similar to what they've got going on in Brooklyn in New York, vertical warehousing. So what we found is these bigger trucks, they're carrying two trailers, not one. They require bigger courtyards. There's technology that has to be deployed, additional parking, there's going to be kind of navigation systems that are put into the buildings. So all of that I think is going to force us to go into more of increasingly a vertical model. We can't go and afford seven to one land to building ratios, already four to one was expensive. So I think what these trucks are going to do is accelerate the trend towards vertical warehousing.

Matt McGregor: And you mentioned vertical warehousing for those listening to the podcasts that are not as familiar with it. Seattle actually was the first introduction through Prologis of a vertical warehouse in the United States modeled after some that were done in Japan and other countries. So we, Prologis, constructed at three-story 500 and I think 60,000 foot multi-story warehouse where you could actually drive the trucks up to the upper levels. It was fully leased by Amazon and Home Depot and now we've got four other projects slated in the close end market in Seattle and we're hearing of others across the United States. Are you seeing that in a lot of markets? And which markets have been successful with it?

K.C. Conway: Yeah, so so far you guys have led, it's been followed up in New York. It's the really high dense markets where you can't get land, you can't assemble it, and you've got really high dense populations where it makes sense. So the parallel to what you guys led on in Seattle is a deal with Goldman and I think DH Holdings in Brooklyn, that's a three-story deal. So we're really seeing them there. Here are the two impediments that we're finding, the first is capital doesn't understand them. So your permanent debt lenders, your institutional folks, they kind of are saying, "Wait a minute, did you take us back to the future? Are we back in 1930 and 40 with Sears and Montgomery Wards doing vertical warehousing?" We all probably have an old Sears vertical distribution somewhere that if it didn't get torn down, it's now being made into apartments or houses.

Matt McGregor: [inaudible 00:00:11:59].

K.C. Conway: Yeah, that's right. So I think that's the biggest impediment. None of the capital players are courageous enough yet to really want to jump in and do debt deal, life companies don't know about it. I'm on a board of directors for a public [inaudible 00:12:13] Monmouth, we're studying it, but right now we're kind of staying safe to what we know and I think it's going to take a little time for people to warm to them. Here's what I think will make them warm, you put those nice credit, known tenant names on a 15 year triple net lease, no inflation costs, good bumps and whatnot. They don't care what the building, whether it's horizontal or vertical, it just pays and it pays really well, and I think they will warm to it.

Bill Condon: Yeah, that's a good point. I mean there would be a number of groups wanting to buy that if Prologis were to sell that, which they won't, lining up to buy that triple story warehouse here in Seattle. So really insightful stuff. K.C., on the autonomous trucking and vertical warehouses. Another thing we hear often about is 3D printing. We'd love to get your insights, your thoughts on 3D printing and how that might impact our industry.

K.C. Conway: Yeah, so I was in the camp three to five years ago. It was going to be much more disruptive than it appears to be developing. I think the 3D printing impact is much more in the areas of apparel, and medical, and pharmaceutical, which are going to disrupt, I think drug store and kind of apparel type stuff and medical. And I think regardless, the problem they have with 3D printing, how do you create the product and inventory quick enough and in a bulk fashion? And I don't think it's going to eliminate the need for warehousing. I think what it's going to do is it's going to increasingly, kind of link the eCommerce and online activity to kind of figuring out and perfecting your last mile. I use a good example of grocers, ALDI and Lidl do a really good job.

K.C. Conway: You can have four of their stores in the same city. Trader Joe's I think is another good example, Whole Foods. But if you go into one of those stores on the east side of town and then another one on the west side of town, the product offering is totally different because they understand their demographic and the product. And so I think 3D printing will enable retailers to understand, let's take Asprin, "The caplets sell better than gelcaps in this particular market, so we're going to bulk up on this side of town or this region for that product." So I think we're always going to need the warehouse so you just can't, I don't think in the next decade, can bulk up enough the production and inventory in the 3D print process. But maybe in the next decade, and they 3D printed some new hair and it's brown and not gray on me I'll be very happy and change my opinion back, but I don't think it's yet going to be that disruptive. It'll come, but not in the near, one to three, four year time horizon.

Bill Condon: What are a few of the markets that you think across the country will have the biggest rent growth in 2020?

K.C. Conway: Right. So I think when you look at your big primary markets that are aligned with major ports, so you got LA and Long Beach on the west coast, you've got Seattle. You look at a Dallas, you look at an Atlanta, New York, Chicago, those markets, you're almost fully priced. I mean, we're down into the three and four cap rate ranges. I think you're fully priced. Priced to perfection. So rents are going to be slower to go.

K.C. Conway: And as the retailers where they built out kind of their supply chain in those major markets aligned with ports and intermodal and inland ports, they now have reached their tentacles into the secondary markets and put them together. So, a market that just blew me away recently that might surprise some is Salt Lake City on your part of the country. Salt Lake city is just on fire. The infrastructure's there. New airport, rail, interstate, air cargo with a Delta hub. It's very affordable and a couple of things are happening. The west coast markets are finding it is a very cheap place compared to the west coast to go to, and so if you're dealing with more of a warehousing, distribution, manufacturing process, you got to get inland. It used to be a Denver bet, that's out of price controls today. So Salt Lake is one. The other thing that's happening in Salt Lake is there's a cannabis backlash from Colorado, so all of your transportation workers, your transportation maintenance people, they can't pass their random TSA drug tests that are given during the year.

K.C. Conway: They might've had a brownie at the wrong weekend while they were skiing over in Vail. And so we're seeing a ton of transportation, transportation maintenance companies pack up out of Colorado and Denver and move into Salt Lake. So Salt Lake is one I think is phenomenal. Another one is Phoenix. Phoenix is an affordability play off the west coast. It's also from a physical infrastructure, the NAFTA highway is there. I love in the Texas markets, Houston is going to be a big one. I'll give you a kind of a contrarian play. So the Houston port and chip channel is congested. It requires a lot of dredging. You got a square off going between the chemical and petro industries that want the tankers having most of the traffic in the in and out versus the growth in container ships.

K.C. Conway: And so they're trying to push them out. Last year they tried to put restrictions on how many could make calls in the Houston port. They're sitting on the alternative solution in their backyard. It's called Port Freeport. And so Port Freeport is going to become to Dallas what The Port of Savannah became to Atlanta, it's main port connection supply chain. I would look in study south and I guess that's east of the Houston port going down through Roseburg, down from Sugarland and Fort Bend County.

K.C. Conway: You've also got three 1-class railroads that connect there. The other one we're seeing is in my backyard Mobile. We're one of the deepest ports in the Gulf Coast and believe it or not, we have more class-1 railroads that connect to the Port of Mobile. We have five of them. Problem is we didn't invest in anything in Alabama until last year we passed legislation to finally start rebuilding and, and putting money into our port. We only had two gantry cranes that couldn't even unload Gilligan's Island's boat that crashed on the rear Island. They were old gantry cranes that didn't have the height or the weight. So we're finally putting money into there. I'd keep an eye on Mobile. We've seen Walmart start developing their alternative supply chain distribution center there in Mobile. That'll bring a lot of stuff out of the Panama Canal and the Gulf and supply, really the whole Gulf region.

K.C. Conway: So I like Mobile as a contrary in play. And I'll give you one other one, keep going south, is Lakeland, Florida. So it's the central part of Florida between Orlando and Tampa. And I describe it as the other inland empire in the United States. Florida's finally figured out what you guys did on the west coast with LA and Long Beach in developing the inland empire. And what they're doing is connecting and bringing all of the merchandise and containers and cargo from Miami and Jacksonville and Tampa into a central point in the central part of Florida in Lakeland. And it is amazing whether it's home Depot or grocery or auto parts, it is the inland empire of Florida servicing a really large geographic market. So those are kind of my top picks. Salt Lake is one to go study. A lot of money will be made there. You can buy it very affordable and probably it'd be like buying warehouses in Denver, but a year before they legalized cannabis and recreational marijuana. It's an amazing market.

Matt McGregor: Interesting. Well thank you for that K.C.. We do have one final question. Every year we have different things that we're tracking. You mentioned that 3D printing maybe not as significant as it once was rumored to be or thought to be. My question is on Blockchain. We've been hearing this significantly for two years now. How is it going to impact distribution and fulfillment? Is it in 2020? What's your thoughts on that?

K.C. Conway: Yeah, it really is a big deal. And again, on top of it ... Just so many reasons we want to track basically the inventory and where things go, and how they move, and how supply chain works, and really more information, more big data. So I just read over the holidays, it's in Europe, it's a German grocer that has figured out how to embed Blockchain into it's meat and they can track all the way down to a one pound, two pound package of ground beef to where it came from and where it went in the whole supply chain. So I think it is very real. It is ideally suited for really not just tracking and knowing the information on our physical real estate assets, but really the inventory that comes in and out of there. So it's a big deal.

K.C. Conway: I think it's going to be driven by really both as suppliers and the end retailers really needing to know where inventory goes, how it gets there, the time [inaudible 00:21:07]. So much information they need, and Blockchain enables you in a secure fashion to almost track and know unlimited information. So it really is a big deal. I think industrial real estate more so than any other property type is probably going to be the biggest impacted and beneficiary. The warning on that is, I don't know how many out there listening have developed a new modern warehouse recently. So if you look at typically a year and a half, two years ago, I use my own experience with FedEx. Monmouth is one of the primary landlords for FedEx warehouses, their modern stuff. A new FedEx warehouse, supply chain, e-commerce might've cost in the range of a hundred bucks a square foot two years ago.

K.C. Conway: Fast forward two years, it's about 135 bucks a square foot. And what's driving that is obviously one, you need more land, so your land costs are going up, your construction costs are going up, but a lot of other costs are going up. The technology that's going into these buildings. It's not just tilt up concrete anymore. There's all kinds of technology that goes in that box. And I think the last element that goes into it, is look at the rising construction costs. We're still recovering from five category three and four hurricanes. I don't think we see any relief there in compounding that. Anybody that's looked at their recent property casualty insurance or their property tax bills are looking at 20, 30, and 40% increases. So the intangible price is going up. We're just going to have to find more and more efficiencies in the warehouse supply chain. And I think that's the opportunity and risk for this stuff is what you may proforma today, by the time you finish it, you may have some pretty serious cost overrun. So protect yourself, hedge yourself on how that situation could happen.

Matt McGregor: Great insights. K.C., we just want to say thank you so much. As usual, you're brilliant. It's an honor to have you on our program. We appreciate it so much. We're going to of course hold you to these predictions and monitor it as the year goes on. K.C., thank you so much.

K.C. Conway: You all be good until the summer. Go on vacation. Don't come back from vacation. Stay abroad until the elections are over to know if we saved the country. It's going to be a wild ride in the fall.

Matt McGregor: That's right, it will be.

Bill Condon: Thank you K.C..

K.C. Conway: Take care. Have a good year.

Matt McGregor: Thank you so much.

K.C. Conway: Buh-bye.

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