TABLE OF CONTENTS
PAST: WORLD RESERVE CURRENCIES
2-4
PRESENT: KING DOLLAR
4-6
1 FUTURE: BRICS?
7-9
TEXAS REGION OUTLOOK
10-11
MIDWEST REGION OUTLOOK
12-13
SOUTHWEST REGION OUTLOOK
Take a look inside any warehouse or factory and you’re likely to find it full of products either made abroad or assembled here in the United States using foreign parts. Since the 1990s, American imports have surged past exports, creating unprecedented growth in the industrial real estate market centered around big-box warehouses. Although not well acknowledged, this growth was made possible because of the dollar’s status as the world reserve currency which has allowed the U.S. to run the largest trade deficits in world history.
In the modern era, multiple currencies have held the title of world reserve currency. Before the U.S. dollar, there was the British pound sterling, which succeeded the Dutch guilder and the Spanish silver dollar. As history shows, changes in world reserve currencies have always coincided with shifts in global economic power. Since post-World War II, the dollar has formally served as the global currency of choice because of its impact on the world economy. However, economic power has been shifting from West to East since the turn of the century and not surprisingly, the dollar’s status is also changing.
Given its dependency on the dollar, the emergence of a new world reserve currency would fundamentally change America’s industrial real estate industry. Despite the challenges this poses, a new reserve currency can create once-in-a-lifetime opportunities in the industrial market this decade. Imported products have played a major role in the industrial market, but the future will likely be predicated on industrial properties used in the production of export goods.
PART I: KING DOLLAR & INDUSTRIAL REAL ESTATE
PAST: WORLD RESERVE CURRENCIES
If a gasoline company in China wants to purchase oil from Saudi Arabia, the two are likely to settle the transaction in U.S. dollars, even though America had nothing to do with the deal. While the dollar’s role may seem unnecessary, history shows that international trade flourishes when conducted with a single trusted currency. In addition to its use as the preferred medium of exchange, the dollar is held on “reserve” by foreign central banks to support the value of their own currencies. This concept of a world reserve currency developed over time, so, to understand why the dollar’s role is changing, it helps to take a quick look at the past to understand why reserve currencies rise and fall.
Dutch Guilder
The Rise 17th Century
The Spanish silver dollar that circulated during the 16th and 17th centuries is widely recognized as the first universal medium of exchange. However, it was the silver coin minted by the Dutch, known as the guilder, that became the first world reserve currency as the concept is known today. After declaring its independence from Spain in 1581, the Netherlands essentially created what has come to be known as capitalism. The highly educated Dutch people invented and built some of the greatest ships of that era, allowing the Netherlands to generate immense wealth by establishing trading posts around the world. In 1602, the Dutch founded the East India Company (known as the VOC), the world’s first publicly traded corporation, which necessitated the creation of the first stock exchange in his story, the Amsterdam Stock Exchange.
All merchants wishing to do business with the East India Company were required to open up accounts at the Bank of Amsterdam, which issued notes that were redeemable in guilders held on “reserve” at the bank. At the height of the Dutch empire, the East India Company accounted for one-third of world trade, allowing the guilder to become the prominent medium of exchange throughout Europe and parts of Asia (The Changing World Order).
The Fall - 18th Century
During the “Dutch Golden Age”, the rulers of the Netherlands enjoyed lavish lifestyles at the expense of taxpayers. To maintain its territories around the world, the Dutch waged multiple wars, which further exhausted tax revenues, resulting in large budget deficits. Fittingly, the inventors of capitalism were outdone by competition. The British founded their own East India Company and quickly became a major rival to the VOC by gaining a competitive advantage in new trades such as tea. To support both the struggling VOC and their overextended government, the Bank of Amsterdam recklessly inflated the money supply by printing banknotes that were not fully backed by physical guilders. The inflation of the guilder banknote backfired with soaring prices and ignited a classic “run on the bank” as depositors redeemed their worthless banknotes for as much silver as possible. Having already been surpassed economically by the British decades earlier, by the end of the 18th century, the Bank of Amsterdam collapsed, the VOC went bankrupt, and the guilder’s dominance in global trade concluded.
British Pound Sterling
The Rise - 18th Century
The most transformative period in human history began in England in the mid-1700s thanks to the innovations in iron making and steam power that kicked off the Industrial Revolution. Raw materials such as cotton were imported largely from British colonies in America and used to manufacture and export low-cost and high-quality goods like textiles, resulting in large trade surpluses. When the Bank of Amsterdam collapsed, depositors transferred their savings of silver to banks in London, which helped fuel Great Britain’s manufacturing industry.
By 1800, the Dutch guilder was supplanted by the British pound sterling, which was an accounting system that consisted of coins composed of sterling silver. In 1821, the British redefined the pound sterling as a weight of gold, ushering in the Gold Standard era. At the nation’s peak around 1870, 60 percent of global trade was denominated in pounds and British territories claimed 20 percent of the world’s landmass from India to Canada, which birthed the saying, “The sun never sets on the British Empire” (TCWO).
The Fall - 20th Century
The British eventually lost their competitive edge in world trade by the late 1800s with the emergence of the U.S. and Germany. However, the role of the pound sterling did not come into question until World War I. To help finance the war, the Bank of England stopped redeeming pound sterling banknotes for gold and heavily inflated the money supply. Consequently, the pound sterling collapsed in value as prices rose by an average of 15 percent each year from 1914 to 1918 (Bank of England).
After the war concluded in 1918, the Bank of England attempted to resume the gold standard but did not deflate the money supply. Too many banknotes backed by too little gold caused a bank run reminiscent of the Bank of Amsterdam. During the 1920s, British exports dwindled to 75 percent of their 1913 level as manufacturing declined, and by 1928, the nation ran massive trade deficits to the tune of £351 million; equivalent to more than $165 billion based on today’s price of gold (Center for Economic Policy Research, Hodder Education Magazines). The Great Depression and World War II further weakened Great Britain’s economy. With India’s independence in 1947, the sun had finally set on the British Empire and the pound sterling.
1793 Dut ch Guilder
1927 Gold Sovereign
HOW IT STARTED
Borrowing to Produce
Having recently declared its independence from Great Britain, America in 1800 was a relatively poor agrarian nation with little savings. But by the end of the 19th century, Americans surpassed the British as the wealthiest industrialized nation in the world. America’s magical growth formula was simple, unprecedented economic freedom. With this freedom, American entrepreneurs borrowed heavily from the world (primarily from the British who were flushed with savings) to expand its productive capacity. Throughout the 1800s, Americans imported tools, machinery, and steam engines to establish farms, mines, canals, and railroads. This was reflected in the nation’s balance of trade where from 1790 to 1873 the U.S. ran an accu mulative trade deficit of $2.3 billion (or about $221 billion based on today’s gold price).
U.S. MERCHANDISE TRADE
Cumulative Balance of Exports Net Imports 1790 - 1900
$2,000
$1,500
$1,000
$500
$0
Source: National Bureau of Economic Research
As the 1920s came roaring along, the United States was well ahead of Great Britain as the global leader in manufacturing, international trade, and notably the biggest holder of gold. While the dollar’s usage around the world steadily increased, it did not formally supplant the pound sterling until the conclusion of WWII. In the summer of 1944, the Allied nations met in Bretton Woods, New Hampshire, to iron out a new world order. The United Nations, World Bank, and International Monetary Fund (IMF) were all formalized during the Bretton Woods Conference. The U.S. became a major custodian of gold owned by nations who participated in the war and in return, these nations received paper dollars that were fully redeemable in gold bars known as bullion at $35 per troy ounce (paper dollars held by U.S. citizens were no longer redeemable in gold coin effective 1934). Foreigners held dollars on reserve as a means to back their own paper currencies and borrowed dollars to purchase goods from the U.S. to rebuild their economies after the war. By 1947, the U.S. held 61 percent of the world’s gold reserves, and “King Dollar” took the crown as world reserve currency.
Impact on Industrial Market
Americans then built factories and their advanced infrastructure allowed them to cheaply transport manufactured goods from inland to seaports to be exported. Starting in 1874, America’s balance of trade flipped and deficits became surpluses. During this time, the U.S. overtook Great Britain as the leader of innovations as Cornelius Vanderbilt’s railroads, John D. Rockefeller’s oil, Andrew Carnegie’s steel, Thomas Edison’s electricity, and J.P. Morgan’s finance ushered in the Second Industrial Revolution. America’s productive capacity became so vast that it was able to effectively repay the debt to the world it had accumulated since 1790 in just 23 years. By 1900, America’s annual exports exceeded imports by over $500 million and remarkably began the 20th century with a running trade surplus of $1.8 billion (over $177 billion in today’s gold prices).
A strong manufacturing industry enabled the U.S. to consistently run trade surpluses for nearly 100 years. Small and mid-size properties were often used to conduct most manufacturing activities, and industrial real estate deliveries reflected that. For example, during the 1960s, 34 percent of all new deliveries were concentrated among properties ranging from 10,000 to 50,000 square feet, 37 percent between 50,000 and 200,000-square-foot range, and 28 percent in warehouses over 200,000 square feet (CoStar). Although properties over 200,000 square feet are primarily built for warehousing and logistics today, these buildings were often developed as hybrid factories and warehouses in the past. New deliveries would cater toward small industrial and mid-size properties until the 1990s but it was what occurred two decades earlier that changed the course of America’s economy and the industrial market.
1928 Do u ble Eagle
1879 Sil v er Dollar
End of the Gold Standard
Following WWII, the U.S. government slashed wartime spending and after a brief recession, the economy boomed for the better part of the next 25 years. Unfortunately, it was at this time that the U.S. began to follow in the footsteps of the British and Dutch. The fall of the British Empire made room for America to establish military bases in other countries. Following global conflicts such as the Cold War, the Korean War, and the Vietnam War, government deficits increased during the 1950s and 1960s. The expansion of social welfare programs such as Social Security and missions to the moon also exhausted tax revenues, and from 1960 to 1970 the national debt rose by $92 billion to a new high of $383 billion (U.S. Treasury).
Countries with United States military bases and facilities.
Mounting budget deficits were financed with the help of the Federal Reserve’s printing press which artificially lowered interest rates. As the U.S. inflated the money supply, dollars spread around the world when Americans used inflated dollars (and credit) to purchase goods from foreigners. By 1966, foreigners held $14 billion, but the U.S. only had $3.2 billion worth of gold on reserve to cover foreign dollar holdings (IMF). Eerily similar to the Netherlands and Great Britain, America experienced a bank run. Led by the French, foreign governments redeemed their gold by the billions of dollars, and America’s reserves, which stood at more than 20,000 tons in 1947, collapsed to about 8,100 tons in 1971 (World Gold Council).
On August 15, 1971, President Nixon announced to the world on a live broadcast that the U.S. would “temporarily” suspend the gold standard. However, the U.S. never returned to the gold standard and for the first time in human history, the world economy began operating on unbacked (fiat) currency. The failure of the government to cut spending gave way to runaway inflation during the 1970s and the Consumer Price Index (CPI) doubled. As the dollar plummeted in value against foreign currencies, the price of gold soared, peaking at $850 per ounce in 1980.
The dollar needed a lifeline; in 1979, the U.S. brokered a deal with Saudi Arabia. The largest oil exporter in the world agreed to price its oil only in U.S. dollars in return for military protection, giving rise to the “petrodollar.” Foreigners may have lost their taste for dollars but needed the greenback to buy oil. A year later, the Federal Reserve, led by Paul Volcker, pushed up its key interest rate to 20 percent (the highest level on record), causing demand for dollars to rise (savings rates). By the mid-1980s, the dollar regained its global footing and the absence of a major economic competitor preserved the dollar’s reserve currency status.
U.S.
MERCHANDISE TRADE
Balance of Exports Net Imports
Source: U.S. Census Bureau
Despite the actions of Paul Volcker and the deal with the Saudis, America’s fundamental problem of big budget deficits would persist, again necessitating inflation and artificially low-interest rates. Consequently, saving rates plummeted, contributing to the significant decline in manufacturing. Similar to Great Britain in the 1920s, America’s long-running trade surpluses morphed into large deficits. Not coincidentally, this trend started the same year the gold standard ended. The very structure of the American economy began to change in the 1970s and instead of domestic production, the economy is now dependent upon imports.
Borrowing to Consume
American manufacturing, as it exists today, is largely absent of industries it once dominated 40 years ago, that imports now make up such as clothing, home goods, and electronics. While the Fed reports that annual manufacturing output (adjusted for prices) remains near historic highs at $4.1 trillion in 2023, this data is based on the CPI’s new methodology. As covered in previous issues of the Industrial Watch, the CPI has undergone multiple changes since the 1980s to intentionally report lower increases in prices. Therefore, today’s manufacturing output is overstated compared to past years. Although the U.S. still maintains the second-largest manufacturing base in the world, many of the nation’s factories are essentially assembly shops reliant upon foreign-made components. Furthermore, 47 percent of imports are consumer goods that can’t be used in manufacturing and are worth less the minute they are purchased (American Enterprise Institute). Unlike the 19th century, America today doesn’t borrow from the world to expand its productive capacity but to consume and, at best maintain manufacturing. In other words, the U.S. does not have the economic means to repay the nearly $21 trillion in trade deficits accumulated since 1971 in real goods.
Impact on Industrial Market
The substitution of homegrown manufactured goods for imports completely transformed the industrial real estate market. More imports equal more demand for large warehouses and logistics facilities, especially near major ports of entry such as the ports of Los Angeles and Long Beach that have direct shipping access to America’s major trading partners in East Asia. Not coincidentally, as America’s trade deficits deepened, so did the share of deliveries of big-box warehouses. Starting in the 1990s, big-box overtook small industrial, making up 36 percent of total deliveries, and began to dominate supply a decade later. In recent years, big-box has accounted for 73 percent of all new industrial properties delivered as America’s trade deficits soared past $1 trillion.
FUTURE: BRICS?
Emergence of BRICS
In 2001, Goldman Sachs economist Jim O’Neill coined the acronym B.R.I.C to describe the fast-growing economies of Brazil, Russia, India, and China. Eight years later, the heads of state among the BRIC nations gathered together and organized a formal coalition, extending membership to South Africa a year later to create the BRICS. Years went by and the BRICS quietly yet steadily formed tighter economic par tnerships. Then in 2023, the BRICS bombarded global headlines.
This past summer, the BRICS met for their annual summit attended by heads of 30 other countries and for the first time in a decade, extended membership to six nations: Argentina, Egypt, Ethiopia, Iran, Saudi Arabia, and the United Arab Emirates (UAE). Despite their political differences, the BRICS, led by China, have one common goal that unites them, to reduce their dependency on the U.S. dollar (a movement known as de-dollarization). Experts in the U.S. have largely downplayed the BRICS but history shows that the emergence of a global economic force should not be overlooked.
Much like the U.S. was in 1800, China was a poor agrarian nation in 1980. Outside of Hong Kong’s Hopewell Centre (built during British occupation), China didn’t register an address on the list of the world’s 100 tallest buildings (Skylines & Scrapers). But at the time, China was undergoing fundamental changes to its communist economy to adopt a more free-market approach, just as America chose to do following its independence from Great Britain. Four decades later, China has remarkably overtaken the U.S. as the largest economy in the world with a gross domestic product (GDP) of $25 trillion based on the purchasing power of its currency (CIA).
In addition to welcoming foreign investment, the “China Miracle” allowed the Chinese to generate the world’s largest pool of capital with an average household savings rate of 33 percent since the early 1990s (OECD). The Chinese used their savings to develop the largest manufacturing base in the world, producing about $7 trillion worth of goods in 2021 (The World Bank, CIA). With an abundant supply of low-cost high-quality goods, China has quickly become the central player in international trade, accounting for 15.1 percent of global merchandise exports in 2021 – nearly twice the level of the U.S. (WTO). With regard to the tallest buildings in the world today, China dominates the list with 47 and accounts for 40 of the 50 tallest buildings currently under construction (Wikipedia).
U.S. INDUSTRIAL DELIVERIES
Source: CoStar
Small Industrial (10K - 50K SF) Mid-Size (50K - 200K SF) Big-Box (Over 200K SF)
Top 50 Metros
Shanghai, China 1990 vs. 2010
2022 Top 10 Largest Oil Producers
Source: U.S. Energy Information Administration. Bold Indicates BRICS membership.
With their recent additions, the BRICS now account for 36.4 percent of the global GDP and 44.4 percent of the world’s population (CIA, Wikipedia). Equally as important, six of the top 10 oil producers in the world are BRICS members, including the top oil exporter and cofounder of the petrodollar, Saudi Arabia. Given that two other nations on the list have expressed interest in joining the coalition, the possibility of the BRICS using non-dollar currencies to trade key commodities such as oil is now becoming a reality. Just recently, companies in China and France used yuan to trade natural gas produced in the UAE and India made its first purchase of oil from the UAE using rupees. While multiple fiat currencies are being used to replace the dollar, the future of international trade is setting up to resemble the past.
CENTRAL BANKS NET GOLD PURCHASES/SALES
In building their economic empire, the Chinese simply followed the same roadmap drawn by the Dutch, British, and Americans. China leveraged its savings to become a manufacturing powerhouse, became the central player in international trade, and is now accumulating a massive amount of precious metals. In 2010, a monumental shift occurred amongst central banks; for the first time since the 1980s, monetary authorities, not surprisingly led by China and Russia, became net buyers of gold. After the U.S. inflated its money supply by a record 40 percent during the pandemic, foreign central banks responded by adding the most gold to their reserves on record with the addition of 1,078 tons in 2022 and continued their buying spree last year (FRED, World Gold Council). While Russia’s state-sponsored media, Russia Today (RT), circulated rumors of a gold-backed BRICS currency last summer, the leading candidate for the next world reserve currency is China’s yuan - given the nation is also the top producer of gold in the world. In 2022, the Chinese launched a digital yuan and in October, the easy-to-use currency facilitated its first international trade in oil. If the Chinese back the digital yuan with its stockpile of gold, the currency could realistically attract other nations to adopt it as a reserve currency, especially if global inflation worsens.
Catalysts for Change
From 2001 to 2021, the dollar’s share of central bank reserves dropped from 73 percent to about 55 percent and, in 2022, it tumbled to a historic low of 47 percent (Kitco). The direction of the dollar’s use in international trade is already on the decline but the important question remains, if the dollar loses its reserve currency status, what could be the trigger? As was the case multiple times in the past, it could be a combination of an economic downturn and global conflicts.
For decades, nations like China have interfered in currency markets to prop up the dollar’s value. When the U.S. prints money and exports dollars through trade, foreigners print money to buy those dollars to ensure stable exchange rates. A popular tool known as the Big-Mac Index (which compares the cost of the burger in different currencies) shows that the yuan is 37 percent undervalued against the dollar based on purchasing power (The Economist). On the flip side, the dollar’s 59 percent overvaluation allows Americans to live above their means (of production) by importing more than they export, but only because the Chinese are living below their means. Side effects of the world importing America’s inflation include asset bubbles, which may consist of China’s real estate boom that turned bust in 2023.
Golden BRICS
Source: World Gold Council
The inflated dollars that America’s trading partners absorb through trade are then circulated back to the U.S. when foreigners purchase U.S. assets like real estate, stocks, corporate bonds, and Treasuries, the latter of which are held along with dollars by central banks as reserves. Before the U.S. abandoned the gold standard, foreigners only held $20 billion worth of Treasuries in 1970, accounting for 7 percent of the national debt held by the public. Today, that figure has ballooned to $7.6 trillion, representing 29 percent of publicly owned federal debt. Accounting for all financial assets, the U.S., economically speaking, owes the world $18 trillion on net as of mid-2023 (BEA). Never before in history has a global economic imbalance remotely existed to this degree.
As explained in detail in the previous July 2023 issue of the Industrial Watch, the U.S. is likely on a collision course with a severe recession. In response, the Federal Reserve will probably once again lower interest rates and inflate the money supply to bail out overindebted businesses and primarily finance the government’s mountain of debt. But this time around, will America’s major trading partners (consisting of the BRICS) be willing to absorb U.S. inflation or could this be an opportunity for the emergence of a new world reserve currency? Although de-dollarization could cause a global recession as foreigners redirect resources from American consumers to themselves, economies abroad, notably China’s, could benefit greatly after they allow their currencies to appreciate against the dollar.
Aside from a global inflationary crisis, the BRICS have political reasons to de-dollarize. When the U.S. sanctioned Russia for invading Ukraine by blocking its use of dollar reserves, America unintentionally sent a message to the world that holding dollars or dollar-denominated assets could be a liability. This applies especially to China which held the second most U.S. Treasuries among foreigners at $778 billion in September 2023 (U.S. Treasury). China intends to reclaim U.S.-supported Taiwan, which defected from China in 1949. The island nation manufactures 60 percent of the world’s computer chips, so, it’s no mystery why China wants to “unify” Taiwan with the mainland (The Economist). Any attempt to do so may cause backlash from the U.S., which is partly why China sold off $89 billion worth of Treasuries through the first three quarters of 2023, while repeatedly announcing new gold purchases.
Impact of New Reserve Currency
Since no former world power ever witnessed the economic imbalances that the U.S. does, it is difficult to quantify the full impact Americans will experience if the dollar loses its reserve currency status. Yet America’s trillion-dollar trade deficits will probably be a thing of the past. Initially, trade surpluses may result if foreigners circulate their hoard of dollars back to the U.S., outbidding Americans for valuable goods the U.S. is still capable of producing. Given America’s productive capacity, skyrocketing prices may likely be the outcome.
With regard to the industrial real estate market, properties like big-box warehouses built to facilitate imports would decline along with the dollar. However, the future outlook is not doom and gloom for everyone. Industrial properties needed in the production of globally traded goods should perform well in such an environment, and the good news is that each region of the country offers once-in-a-lifetime opportunities. When the investment community understands the predicament that the U.S. is in, a flood of capital will likely pour into any investment that is “inflation-proof”, providing a windfall to the owners of such properties. For owner-users who aid in the production of globally traded goods, they can generate capital to expand their business to take advantage of rising prices by conducting a
Debt Held by Foreigners M2 Money Supply
Debt Held by Public
TEXAS REGION
Dallas, Houston, Midland/Odessa, San Antonio, Austin
While demand levels were still historically strong, the industrial market in the Lone Star state experienced a noticeable drop last year following a slowdown in 2022. Net absorption among the big four markets totaled nearly 54.5 million square feet in 2023, down about 38 percent annually. Among property types, demand for small industrial space contracted for the first time since 2009 at an estimated 500,000 square feet. In terms of volume, mid-size experienced the steepest drop in demand from 2022, slowing by roughly 13.9 million square feet. On a relative basis, San Antonio led the slowdown in net absorption at 82 percent to 2.0 million square feet. This stall in demand came despite the nearshoring movement that has allowed Mexico to overtake China as America’s top importer, largely benefiting Texas cities near the border.
After attracting large industrial players in recent years such as Tesla and Amazon, the Austin market took a break from the headlines, contributing to a 65 percent fall in absorption with 4.3 million square feet. Houston’s level of demand declined by 41 percent to 18.1 million square feet, even with an uptick in oil refining. Demand for space in Dallas-Fort Worth is expected to slip 12 percent to 30.2 million square feet as the capital-intensive manufacturing-based market confronts higher interest rates. While Midland-Odessa is not a major industrial hub in Texas, the oil-rich market plays a pivotal role in the Texas economy. Thanks to resilient energy prices, demand in the capital of the Permian Basin jumped 54 percent to roughly 446,000 square feet.
Source: CoStar
Record levels of industrial demand in 2021 and 2022 attracted historic levels of speculative supply in Texas last year, three-quarters of which were concentrated in big-box warehouses. Annual net deliveries among the top markets leaped by an estimated 49 percent. Once again, DFW led the way, delivering an estimated 70 million square feet of industrial space, representing a massive 88 percent increase over 2022 levels. As Texas’ second-largest industrial market, Houston followed suit, increasing new development by about 43 percent to 33.7 million square feet. Given the nearshoring boom, deliveries in San Antonio unexpectedly slowed by roughly 11 percent to 8.1 million square feet. After the completion of Tesla’s 4.5 million-square-foot Giga factory in 2022, deliveries in Austin were poised for a drop (slipping 6 percent) but were still historically high at 12.4 million square feet. Since the shake-up in the oil market during the pandemic in which prices briefly traded in negative territory, industrial supply in Midland-Odessa has remained muted, slipping to the lowest level since 2016 at about 260,000 square feet.
Slowing demand plus skyrocketing supply can only equal rising vacancy rates. Despite the narrative that the industrial market is simply returning to “normalcy” after a couple of years of inflated demand during the pandemic, the data tells a different story. The growing gap between supply and demand has resulted in a decade’s high vacancy rate for Dallas-Fort Worth (8.7 percent), San Antonio (7.4 percent), and Austin (10.2 percent). Vacancies in Houston also rose to about 7.1 percent in 2023 but sat below the decade-high of 8.0 percent posted in 2020. Notably, Midland-Odessa was one of the few Texas markets to experience a decline in vacancies, dropping to 7.1 percent. Overall, rising vacancies in Texas have contributed to a deceleration in rent growth but the correlation is not one-to-one. For example, despite vacancies rising faster to a higher level, DFW rents grew 280 basis points faster than Houston at 8.1 percent last year.
FUTURE OPPORTUNITIES
There are very few states in the U.S. that could thrive in an environment where the dollar is not the world reserve currency. And Texas can easily make the best case given that it maintains the largest trade surplus in the nation. Everything is bigger in Texas, including its $487.4 billion worth of exports (supported by the Port of Houston), which accounts for nearly 24 percent of all American goods shipped abroad in 2022. Net imports, Texas trade surplus cleared $103.3 billion in 2022 (International Trade Administration).
Since inflation always benefits those who receive the new currency first (because they can make purchases before prices rise), Texas may be fortunate as the leading recipient of the trillions of dollars that are currently held by foreigners. Although de-dollarization equates to spiking import prices, history shows that the price of valuable commodities like oil will rise even faster, providing a major boost to the Lone Star state and the industrial properties its economy depends on. Unlike the vast majority of all states in the union, Texas will be able to export key commodities that are in high demand around the world in exchange for the manufactured products foreigners produce. Texas tops the U.S. in manufacturing activity, but to the extent that Texas manufacturers (and thus their properties) would fair in response to de-dollarization, may depend heavily on their reliance upon imported supplies that could become less affordable. The more manufacturers are dependent upon domestic supplies the better, which is why investing in Texas manufacturing should be done on a case-by-case basis.
Source: CoStar
Case Study - Pecos Industrial Portfolio
Making up the lion’s share of America’s crude oil production at 42 percent, Texas is synonymous with oil. With 32 facilities largely concentrated in the Houston area, Texas also has the most crude oil refineries and the largest refining capacity, processing one-third of U.S. output (Energy Information Administration). Of course, oil and gas make up the largest share of Texas exports at 33 percent, followed by petroleum and coal products consisting of 17 percent (ITA). As mentioned earlier, in the 1970s, the dollar lost significant value against foreign currencies. Meanwhile, the price of oil skyrocketed from $3 a barrel to $40 by 1980 (EIA, The Washington Post). The 1,230 percent increase in the price of oil far outpaced consumer prices that doubled during the 1970s. A similar move could occur today, taking oil-dependent properties, primarily in Midland-Odessa and Houston, along for the ride.
In the fall of 2022, TAG Industrial closed on a 40,201-square-foot two-building industrial asset located within the Permian Basin in Pecos, Texas (about an hour’s drive southwest of Odessa). The newly-constructed building features 14 total grade-level doors, wash bays, and a high-end office finish. More importantly, the property was occupied by oil and gas sister tenants: Ironclad Energy and Gladiator Energy. With a 10 percent marketed cap rate, the property was acquired well above the 6.7 percent national average at that time. The Pecos industrial market contains a limited supply of 843,000 square feet of inventory and had no projects under construction at the end of 2023. This means that undervalued properties like this could balloon in value as demand for industrial properties in the Permian Basin follows a spike in oil prices.
Cotton
Case Study - Lonestar Farmers Co-op
Oil and gas may serve as the dominant industry but Texas is far more than just a source of energy. Behind BRICS members India and China, the U.S. is the third-largest producer of cotton in the world and ranks first in exports with 35 percent of global shipments. There is a reason why college football’s Cotton Bowl originated in Dallas; 40 percent of the nation’s cotton is produced in Texas, two-thirds of which comes from the High Plains region in the Texas Panhandle (USDA, Plains Cotton Growers). In 2020, roughly $2.8 billion worth of cotton was shipped abroad (mostly to China), representing Texas’ largest agricultural export (USDA). Based on the 1970s, the cotton industry in Texas can witness significant growth if a new world reserve currency emerges. From 1970 to 1980, a pound of cotton surged 245 percent from 29 cents to about $1; more than twice the rate of the CPI (World Bank).
Located adjacent to San Angelo, Texas, between Midland and Austin, sits a newly constructed 52,800-square-foot “super” cotton gin. The stateof-the-art multi-million-dollar gin rises nearly four stories off the ground and the property was designed to accommodate additional equipment to increase production (GoSanAngelo.). To take advantage of potentially surging cotton prices, the operating owners of cotton gins can conduct sale-leasebacks to raise a large amount of capital to quickly expand production. From an investor’s perspective, a cotton gin is a specialized machine that is largely “fixed” to the property, making this a valuable asset in an environment with runaway inflation where vacancies are on the rise. Given the likelihood that cotton prices will outpace overall consumer prices, investors have the opportunity to set rent escalations based on the CPI to help maintain the property’s value.
MIDWEST REGION
Chicago, Kansas City/Saint Louis, Northwest Indiana
STATE OF THE MARKET
Demand Supply
The highest interest rate environment in 15 years had a noticeable impact on industrial demand across TAG’s Midwestern markets that are anchored by the shipping industry. Despite net absorption falling by an estimated 49 percent (which was largely caused by slowing demand for mid-size space), the Chicago market maintained a healthy level of demand at 17.1 million square feet. Industrial demand slid by roughly 76 percent to 5.4 million square feet between the Kansas City and Saint Louis markets. However, in the case of America’s heartland, big-box warehouses were responsible for over two-thirds of the decline in demand. On a relative basis, the biggest drop in demand was claimed by the Northwest Indiana market which is home to the counties of Lake, Newton, Porter, Jasper, LaPorte, St. Joseph, Marshall, and Elkhart. Driven by a contraction in demand for mid-size properties, net absorption fell by an estimated 79 percent to 608,000 square feet, representing one of the lowest levels of the past decade.
After experiencing a delayed reaction to record levels of demand in 2021 and 2022, speculative supply took off in the Windy City last year, pushing net deliveries up 62 percent to a new high of about 35.1 million square feet. At 87 percent, nearly all of the new supply was concentrated among big-box warehouses. Meanwhile, net deliveries in Kansas City and Saint Louis slowed by about 30 percent from historic highs but still expanded inventory by a robust 13.3 million square feet, 84 percent of which was accounted for by big-box. Northwest Indiana posted a record high of 3.8 million square feet in 2023, up 46 percent on the year. Highlighted by the construction of the 1,380,000-square-foot distribution center in Crown Point (Northwest Indiana’s first million-square-foot delivery since 1991), 92 percent of all new supply expanded big-box inventory.
Source: CoStar
Source: CoStar
VACANCY RATES
Vacancy rates across all of TAG markets in the Midwest took an about-face in 2023 from the recent downward trend yet remained in similarly low territory. Chicago vacancies only rose 120 basis points to an estimated 5.1 percent, positioned well below the 8.6 percent level seen a decade ago. Availability in Kansas City and Saint Louis experienced a similar increase of 110 basis points to an expected 4.8 percent. At this level, the vacancy rate is still lower than prior to the pandemic. With the help of the Crown Point delivery, the vacancy rate in Northwest Indiana was estimated to rise by 140 basis points to 4.9 percent. The impact of big-box deliveries in Northwest Indiana highlights the common trend that is occurring across America, including the Midwest, in which the sudden increase in vacancies is being driven by the supply of big-box warehouses. On the other end of the spectrum, vacancy rates among small and mid-size industrial properties remained significantly lower (3.8 percent in Chicago, 3.1 percent in Kansas City/Saint Louis, and 2.6 percent in Northwest Indiana).
FUTURE OPPORTUNITIES
If a new world reserve currency emerges, the Midwest would be significantly impacted by rising import prices, given that it houses the largest shipping and intermodal network in the country. With six Class 1 railroads, the Chicago market serves as the nation’s main interchange point between western and eastern railroads, accounting for about 25 percent of all freight trains and 50 percent of all intermodal trains in the U.S. (Chicago Metropolitan Agency for Planning). In terms of tonnage, Kansas City maintains the nation’s largest rail center and Saint Louis ranks as the third largest rail hub (Kansas City Area Development Council, Saint Louis Regional Freight Way). Northwest Indiana tops all midwestern markets with the largest Great Lakes port located in a single state (Ports of Indiana).
While the Midwest ships a ton of domestically produced manufactured goods and commodities, those railcars are filled with more imports than exports. In 2022, Illinois racked up a -$164.5 billion trade deficit, followed by Indiana at -$44.5 billion, and Missouri with -$11.7 billion. These Midwestern states ran trade deficits even among its largest shared export in chemicals. Missouri’s net export of chemicals (accounting for similar imports) hit -$298 million, which trailed Illinois’ deficit of -$9.9 billion, and Indiana’s -$23.6 billion trade imbalance (ITA). Nonetheless, the Midwest still holds great investment opportunities in industrial markets that have a comparative advantage.
Petroleum and Coal Products
When it comes to recoverable coal reserves, Illinois trails only Montana for the largest supplies in the nation and ranks fourth in the U.S. for its capacity to refine crude oil (EIA). As a result, the state was able to export on net $3.6 billion of petroleum and coal products in 2022 (ITA). Thanks to the advanced intermodal network in Chicago and Saint Louis, along with access to the Mississippi River that deposits into the Gulf of Mexico, petroleum and coal producers are capable of shipping their products around the world. Although green energy usage is rapidly increasing, global demand for petroleum and coal products (dominated by the BRICS) remains near record highs. If foreigners circulate their dollars back to the U.S., the price of these products could witness a repeat of the 1970s. For example, a metric ton of coal sat at $7.80 before the U.S. discontinued the gold standard and peaked at $56.50 in 1981, appreciating 624 percent (World Bank).
Case Study – Miner Enterprises Inc.
Aside from acquiring a coal mine, a practical way of gaining exposure to the upside in coal is to invest in the industrial properties used to manufacture mining equipment, like Miner Enterprises. The company’s 233,000-square-foot manufacturing facility is located approximately 35 miles west of Chicago in Geneva, Illinois. Miner Enterprises produces equipment for a variety of industries, including high-quality suspension and shovel components for the mining industry. Any significant increase in the price of coal products would likely spark demand for mining equipment, generating additional business for companies like Miner Enterprises.
SOUTHWEST REGION
Denver, Salt Lake City, Los Angeles
STATE OF THE MARKET
Demand
Among the markets that TAG Industrial covers, the Southwest region has experienced the same highs and lows in recent years seen nationwide. Demand in Los Angeles hit a record high in 2021 but unlike most markets, the party came to an abrupt end a year later as net absorption continued its pre-pandemic trend. In 2023, demand contracted further and the estimated -14.9 million square feet of negative absorption established the largest deficit on record. Although mid-size properties only account for 38 percent of inventory, 54 percent of the contraction in demand was concentrated within properties between 50,000 and 200,000 square feet.
Despite showing signs of weakness, demand held up better in smaller markets in the Southwest. Demand for industrial space in the Denver market slowed by about 68 percent to a positive absorption of 2.2 million square feet in 2023. However, this level is similar to decade’s lows posted in 2016 and 2020, largely thanks to lower demand for big-box space. Similarly, net absorption in the Salt Lake City market pulled back 75 percent last year to about 2.1 million square feet mostly due to big-box properties.
Supply
Unprecedented levels of supply served as the national narrative in 2023 but record deliveries were not universal throughout the Southwest. Net deliveries in Los Angeles leaped by 68 percent to about 3.4 million square feet yet failed to make new highs. The lack of available land not only explains why deliveries were capped but also why 91 percent of the new supply was evenly distributed between mid-size and big-box warehouses. Denver experienced another round of large deliveries at an estimated 7.8 million square feet, coming up just shy of the record years set in 2021 and 2022. Denver resembled more of the national trend with 59 percent of deliveries going toward big-box warehouses. Notably, Salt Lake City, which contains the smallest amount of industrial inventory among these three markets, supplied the most deliveries with 9.1 million square feet. Big-box warehouses were responsible for 81 percent of the historical year in deliveries.
Source: CoStar
Source: CoStar
Unfortunately, when it came to vacancies, markets across the board in the Southwest followed the national trend. The vacancy rate in Los Angeles increased about 210 basis points to the highest level since 2013; however, thanks to historically tight availability, the rate only touched 4.5 percent. After reverting to its pre-pandemic path in 2022, vacancies in Denver expanded another 200 basis points to an estimated 7.9 percent last year. Salt Lake City took the lead in both deliveries and the biggest increase in vacancies, with the rate jumping by 380 basis points to about 7.0 percent. The divergence between bigbox warehouses and small industrial properties played out once again in the Southwest. Due mostly to high construction costs that restricted supply, the vacancy rates among properties sized 10,000 to 50,000 square feet remained significantly lower than the overall market, sitting at 3.8 percent in Los Angeles, 4.7 percent in Denver, and only 2.4 percent in Salt Lake City.
FUTURE OPPORTUNITIES
The Southwest is highlighted by the largest economy in the U.S., but theoretically, California would not fare too well in a de-dollarized world. In 2022, the Golden State continued its streak as the biggest debtor in the union, racking up a -$322.5 billion trade deficit with the world. However, other states in the Southwest are less reliant upon imports. Utah ran only a -$2.5 billion trade deficit and while Colorado imported nearly twice as much as it exported, their trade imbalance sat at just -$9.8 billion (ITA). Despite the trade deficits, each market area maintains a comparative advantage that industrial real estate investors can take advantage of. On net, California generated a $6 billion trade surplus in petroleum and coal products and as America’s fruit basket, the state exported $2 billion more of agricultural products than it imported. Colorado ranks as the nation’s fifth largest exporter of beef and veal and processed foods topped their list of net exports at $1.9 billion (U.S. Trade Representative, ITA). And for Utah, future investment opportunities are golden, literally.
Gold
Utah’s exports are dominated by a group of goods classified as “primary metal manufactures,” which in the case of Utah is code for gold. At $7.3 billion, the yellow metal is largely responsible for 44 percent of the state’s total exports. Once similar imports are accounted for, Utah exported $3.3 billion worth of primary metal manufactures on net in 2022, making Utah the leading gold exporter in the U.S. (ITA). As detailed earlier, the price of gold skyrocketed during the runaway inflation of the 1970s, rising more than 2,300 percent by 1980. The BRICS have demonstrated a growing appetite for gold since 2010, so it is not farfetched to expect that they will continue to liquidate their dollar reserves by acquiring more gold. Utah is actually sitting on a gold mine and, figuratively, so are many of its industrial properties.
Case Study – Richards Sheet Metal
Richards Sheet Metal is an owner-user of a 90,000-square-foot manufacturing facility in Ogden, Utah, just 37 miles north of downtown Salt Lake City. Since 1928, Richards has specialized in custom, made-to-order mining equipment, manufacturing high-precision parts and welded assemblies. Richards Sheet Metal products are used in the mining of precious metals (gold and silver), minerals, coal, and aggregates. The company’s facility is fitted to house a variety of advanced machinery, which makes it difficult for Richards Sheet Metal to relocate without major disruptions to its business. If rent escalations are tied to the CPI, this property makes an ideal sale-leaseback investment opportunity in an environment with runaway inflation and exploding gold prices.
The idea of a world reserve currency is largely a foreign concept to Americans but the dollar’s role as the dominant medium of exchange is arguably the bedrock of the U.S. economy today, including the industrial real estate market. Since the turn of the century, the dollar’s role in the global economy has been on the decline just as China has emerged as an economic force. History has shown time and again that what is happening now has paved the way for new reserve currencies in the past. Although the dollar may be replaced, causing ripple effects throughout the economy and the industrial market, there are plenty of golden opportunities that lie ahead.
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