The US Manufacturing Renaissance: Driving a Resurgence in Industrial Real Estate

Spring 2016
GE Manufacturing Solutions builds train locomotives and drive wheels for mining trucks at its 1 million-square-foot, built-to-suit plant in Fort Worth, Texas, part of the 18,000-acre Alliance Texas master-planned mixed-use community. (Attendees at NAIOP’s I.CON ’16: Impact Projects conference had the opportunity to participate in a mobile case study of Alliance Texas.)

Developers may be wise to seek out sites and locations that will attract manufacturing uses as well as those that will attract distribution operations.

THE U.S. MANUFACTURING renaissance is a hot topic in commercial real estate these days, but its story is rife with conflicting opinions. Is it really happening? Is it wishful thinking? The answer is that the sector’s reported rebound contains elements of both fact and fiction.

Let’s first take a look at what went wrong. America’s factories generated more goods in the 20th century than those of any other country worldwide. However, following multiple years of contraction as companies sought cheaper labor overseas, the U.S. manufacturing sector was hit hard in 2008 by the Great Recession. Total manufacturing output fell by more than 20 percent, the largest drop in more than 60 years.

By 2010, the manufacturing dominance America had relied on since the late 1800s was officially over. That year, China supplanted the U.S. as the world’s largest manufacturing nation in terms of output. The impact was felt throughout the U.S. economy — and in the commercial real estate sector. Between 2000 and 2009, 5.8 million U.S. jobs disappeared as a result of factory closings and downsizings. The impact on commercial real estate was just as profound. The U.S. manufacturing sector suffered more than 60 million square feet of net occupancy losses, and vacancy rates rose from 5.1 percent in 2000 to nearly 10 percent in 2009.

In the years since the financial crisis ended, U.S. manufacturing has witnessed a dramatic rebound. More companies want to manufacture here now, thanks to a variety of economic and noneconomic location drivers that have evolved to dramatically improve the nation’s competitiveness.

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As wages continue to increase overseas — particularly in China — it is becoming less cost effective to manufacture goods outside the U.S. Clear U.S. advantages like innovation and R&D spending as well as higher labor productivity and skill levels, along with companies’ increased desire for shorter supply chains, add to the appeal of manufacturing in the U.S. Throw in lower energy prices, which help reduce the cost of not only creating goods, but also transporting them, and it isn’t surprising that manufacturers are returning. It isn’t patriotism, it’s price.

At the same time, U.S. manufacturing is not — and never will be — what it once was. Rather, it is experiencing a renaissance through reinvention. The sector looks far different from the past, offering fewer jobs in smaller facilities and demanding higher skills than ever before. Nevertheless, there is great potential for manufacturing as it relates to industrial real estate, supported by positive trends in the development and occupancy of both manufacturing and warehouse/distribution facilities.

Numbers and Trends

The U.S. manufacturing sector has witnessed steady occupancy gains since it hit bottom in 2010, with more than 106 million square feet of positive net absorption in the past five years. As a result, vacancy rates for U.S. manufacturing facilities have fallen by 140 basis points during this period to a current level of 6.6 percent — well below the 10-year average of 7.3 percent.

Meanwhile, manufacturing construction has nearly recovered. An average of 12.5 million square feet of new manufacturing product added per year is close to the prerecession average of 12.6 million square feet. Since 2010, 62.5 million square feet of manufacturing space has come online.

aerial view of industrial building

Nissan manufactures batteries for its Leaf electric vehicle at its 475,000-square foot lithium-ion battery plant in Smyrna, Tennessee, the largest in the U.S. The plant is part of a more than 6 million-square-foot complex where Nissan assembles 640,000 vehicles annually.
Photo courtesy]

The variety in the types of manufacturing plants being built — or repurposed — is too great to be categorized neatly. What can be said is that the headcount per facility is dropping on average, which logically translates to smaller average facility footprints.

Manufacturers have become significantly more interested in repurposing existing facilities for manufacturing. They are also much more willing to lease their land and buildings as opposed to owning them. Several factors may contribute to this trend. First, companies are seeking to add or relocate facilities in shorter time frames and with less capital investment than in the past. Manufacturers also are experiencing greater change and disruption in their businesses. They want to be able to exit locations more easily. And, as the size of manufacturing plants drops, so may the level of investment and commitment. This may translate into leasing being perceived as lower risk than in the past.

The strengthening U.S. manufacturing sector has also bolstered demand for warehousing and distribution space. These two property types have always been interconnected, since manufactured goods must be stored and shipped to end users. In addition to the resulting direct demand for warehousing and distribution capacity, an important ripple effect bears mention. Manufacturing has the highest multiplier effect of any economic sector in the nation. For every $1.00 spent in manufacturing, another $1.37 is added to the economy. This, in turn, drives demand for warehousing.

Exploring the Attraction

According to the Cushman & Wakefield report “Where in the World? Manufacturing Index 2015,” the U.S. today ranks highest in the Americas and fourth globally (jumping five places, from ninth in 2014) as a desirable manufacturing location. Canada and Mexico also rank high, finishing sixth and 14th, respectively.

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When companies consider new locations to realign or expand their manufacturing capacity, they must weigh numerous considerations. Which drivers are evaluated and how they are prioritized will vary according to the company’s industry subsector, existing locations and facilities, customer and supplier bases, major operating costs, technology levels, timing and so forth. The U.S. is increasingly chosen as the destination for manufacturing investment because it often presents the optimal combination of these factors.

These drivers can be considered in two groups: those that have been in place for quite some time and those that have emerged in the past few years.

Looking back a decade or more, the case to be made for the U.S. as a manufacturing base had less to do with its cost structure than with the opportunity to access its customer markets, predictable operating conditions and infrastructure and regulatory frameworks. Specifically, the U.S. has always offered the following desirable traits as tradeoffs against its higher structural costs:

  • More advanced manufacturing technologies, superior quality standards and higher productivity levels.
  • Stronger intellectual property protections and transparent systems for health, safety and environmental standards.
  • Direct access to the world’s largest consumer market.
  • Significant raw material and land resources to feed production.

Falling Energy Costs. In the past several years, average electric power and natural gas costs in the U.S. have dropped precipitously, as America’s unconventional oil and gas reserves — those contained largely in shale formations and extracted using hydraulic fracturing — have been tapped and transported to end users.

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Eroding Labor Cost Premium. During the last decade, the considerable labor cost premium presented by the U.S. as compared to developing economies has gradually eroded when adjusted for productivity. Boston Consulting Group notes that labor rates in China have experienced annual increases of 10 to 20 percent over the past 10 years, while U.S. wages have increased only 2 percent or less annually.     

Supply Chain Developments. Profound developments in global supply chain infrastructure and costs have also helped to direct manufacturers’ focus to the U.S. Supply chain disruptions have occurred when suppliers have gone offline as a result of natural disasters or other catastrophic events. Port slowdowns and inefficiencies can clog up the most heavily trafficked routes, causing additional supply chain disruptions and congestion.

New Business Models. Furthermore, the emergence of new business models emphasizing rapid customer deliveries and shortened product cycles proves to be incompatible with far-flung supply chains.

Growing Subsectors and Locations

The bottom line is that a growing number of companies are reinvesting in U.S. plants and equipment and relocating manufacturing facilities stateside. For example, Nike Inc. announced in May 2015 that it could create up to 10,000 manufacturing jobs in the U.S. Nike joined Wal-Mart Stores Inc., Apple Inc., General Electric Co., Ford Motor Co. and other U.S. businesses in deciding to relocate and create jobs at home. Wal-Mart is also on track with its plan to buy an estimated $250 billion in U.S.-made goods from 2013 to 2023.

This growth has two sources: reshoring by U.S. companies that previously established or moved manufacturing overseas and foreign direct investment (FDI) by companies choosing to establish manufacturing operations in the U.S.

Reshoring is the practice of bringing outsourced services back to their original country. The strongest reshoring has occurred in the transportation equipment, electrical equipment and computer electronics manufacturing sectors. Transportation equipment is also the strongest subsector for FDI, followed by fabricated metal products and plastic/rubber products.

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According to the Reshoring Initiative, a group founded in 2010 to encourage reshoring, this phenomenon has been strongest in the southern U.S. Since 2000, 100 firms have reshored 23,914 jobs to this region. The Midwest follows, with 100 firms bringing 9,674 jobs back to the U.S. The geographic pattern for FDI is similar to that for reshoring. Since 2000, 162 firms have created 46,617 manufacturing jobs in the South. In the Midwest, 46 firms have created 5,742 jobs.

The South, where reshoring and FDI are most pronounced, has accounted for over 40 percent of manufacturing construction deliveries over the past five years. The largest projects tend to gravitate to that region. The reshoring average of 239 jobs per facility in the South (versus 94 in the Midwest) and FDI average of 287 jobs per facility (versus 125 in the Midwest) make sense for these lower-wage, lower-tax, right-to-work Southern states.

According to a 2013 NAIOP Research Foundation report  by L. Nicolas Ronderos, then New York director for Regional Plan Association, the most likely or favored locations for eight manufacturing subsectors expected to expand by 2020 are:

  • Wood products: Southeast and Far West.
  • Nonmetallic mineral products: Southeast and Great Lakes.
  • Primary metals: Great Lakes and Southeast.
  • Fabricated metal products: Great Lakes and Southeast.
  • Transportation equipment: Southeast and Far West.
  • Furniture and related equipment: Southeast and Great Lakes.
  • Food manufacturing: Southeast and Great Lakes.
  • Plastics and rubber products: Great Lakes and Southeast.

From where are these projects coming? More than 50 percent of reshoring to the U.S. has been from China. This is consistent with the huge wave of offshoring to China in the recent past, but is a major change from the view, widely held from 2000 to 2010, that China was indomitable. Mexico, which has been the destination of choice for “near-shoring,” relative to the U.S., is the No. 2 source of reshoring to the U.S. — primarily in the automotive and appliance industries — accounting for 10 percent of reshoring.

FDI is more heavily weighted toward transportation equipment because of the ongoing investment in automotive assembly plants and related suppliers. When it comes to FDI, Germany is on top, accounting for 19 percent of the total since 2000. China’s strong presence, accounting for 18 percent of FDI in the U.S., is consistent with the reshoring trend, since reshoring and FDI are driven by the same financial advantages.

Changing Manufacturing Processes

The most recent data from the U.S. Bureau of Economic Analysis indicate that manufacturers contribute $2.09 trillion to the economy, 12 percent of gross domestic product (GDP). This figure has steadily risen since 2009, when manufacturers contributed $1.73 trillion.

The renaissance is primed to continue. But tomorrow’s manufacturing sector will feature transformative change in areas that will directly impact industrial real estate, including:

  • Increased output in the face of fewer manufacturing jobs.
  • The regionalization of manufacturing.
  • The revolution of assembly lines.

The federal government’s Revitalize American Manufacturing Innovation Act of 2014 authorizes up to seven years of federal support for centers of manufacturing innovation — a network of up to 15 regional institutes, each focused on a unique technology, material or process relevant to advanced manufacturing — seeking to improve manufacturing technologies. Such improvements may lead to greater manufacturing output. However, technological advances in manufacturing are likely to further reduce the need for production workers.

Already, the expansion of manufacturing production outpaces job growth. A 28.5 percent increase in manufacturing output since the cyclical bottom in June 2009 has been accompanied by only a 5.2 percent increase in manufacturing employment. The U.S. today has fewer factories with large employment. Of more than 292,000 manufacturing establishments counted by the Census Bureau, only 824 employed more than 1,000 workers. Today, the average number of employees in a U.S. manufacturing plant is fewer than 40 workers.

The Future of Manufacturing

The future of manufacturing will be about connectivity. As consumers demand more customization, markets will be microsegmented and competition will intensify. Having the capability to manufacture and deliver the right product at the right time to the right place will become an even greater driver of competitive advantage. This will drive the regionalization of manufacturing near large centers of consumer demand.

Pressure to get products to market faster, cheaper and better will increase. This will drive tremendous innovation in workflow, production lines and simultaneous production, as “design, source, build and assemble” all happen in seamless ecosystems of manufacturing clusters. Production will become superautomated and highly digitized. Real-time reporting, robotics, soft tooling and 3-D printing will revolutionize assembly lines.

What is the takeaway for commercial real estate practitioners? Yes, U.S. manufacturing is rebounding strongly, driven by both reshoring and foreign direct investment focused on select regions and sectors. And, as always, the health of this vital sector makes a significant, positive impact not only on manufacturing real estate performance but on warehouse and distribution demand as well.

When considering the location and nature of future investments, ground-up developers may be wise to focus attention on sites and locations that will attract manufacturing uses as well as those that will attract distribution operations. The most attractive properties will offer more robust and competitively priced utility services, zoning to allow for a variety of industrial uses and lower nominal property tax rates. Additionally, developers may benefit from focusing more effort on identifying and evaluating existing buildings that can be repurposed for manufacturing users seeking greater speed to market.