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The System of Systems

System of Systems
By: Michael Hoban
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As the Nation Awaits Repairs to Infrastructure, Industrial Specialists Are Adapting

At the time of this writing, the U.S. stands to lose its global competitive edge if Congress fails to take action on a pair substantial infrastructure bills, but astute industrial specialists are still finding opportunities in an evolving market.

Back in the 1970s, Fram Oil Filters began a long-running television ad campaign featuring an auto mechanic imploring customers to get regular oil changes—which included their oil filter—to prevent catastrophic engine failure. The tagline was essentially this, “You can pay me a little now, or you can pay me a lot later.” The slogan often surfaces when business cases for preventive maintenance are made for everything from property management to healthcare, but it may be time to revive it once again as the country tries to move forward on two massive and long-overdue infrastructure bills.

A pair of reports issued earlier this year by the American Society of Civil Engineers (ASCE) analyzed the current state and potential future of America’s infrastructure, and the results aren’t pretty. The first report, Failure to Act: Economic Impacts of Status Quo Investment Across Infrastructure Systems, forecasts that the U.S. economy will lose more than $10.3 trillion in U.S. Gross Domestic Product (GDP) by 2039 if investment levels remain the same. Losses would include $2.4 trillion in exports, $1.8 trillion in imports into the U.S. economy (resulting in a $4 trillion loss of trade), and a loss of more than three million jobs. On a consumer level, inaction would drain more than $3,300 from a family’s annual disposable income each year from 2020 to 2039.

“First of all, there had better be a bill (passed),” said Maria Lehman, incoming president of the ASCE for the 2022-2023 term. “The needs for rebuilding our infrastructure are $5.9 trillion, and we’re spending just shy of $3.3 trillion, so not doing something is not the answer because it just keeps getting worse and worse.”

A second study, the quadrennial Report Card for America's Infrastructure released earlier this year, paints an equally troubling picture, even though the grade for the overall infrastructure actually improved from a D+ in 2017, to C-. America’s roads received a D grade, with 43% considered in poor or mediocre condition, costing motorists over $1,000 each year in wasted time and fuel. Bridges fared better with a C grade, but 42% of all bridges are at least 50 years old, with a repair price tag of $125 billion. On a brighter note, rail (B) and the ports (B-), two vital links in the supply chain, received respectable grades, in part because freight rail is almost entirely privately funded, and many ports are privately owned and operated (with others managed by a government or a quasi-government authority.) The report also emphasizes that although there are 17 categories being assessed individually, infrastructure as a whole is now more connected than ever before.

“I think one of the things we learned during the pandemic is that infrastructure is a system of systems, and it’s the weakest link that breaks everything down,” said Lehman. To illustrate, she points to the toilet paper shortage during the pandemic. While acknowledging that some demand was accelerated by hoarding, both the source material (trees) and the production plants were well distributed across the country, yet the supply chain failed. “[The product] was non-high tech and we still couldn’t figure it out for nine months. And now we can’t get microchips to build and sell cars, and that’s 100 times more complicated. So we have to get smarter about being resilient in supply chain logistics, because we can’t build a healthy economy on a crumbling infrastructure.”

If the U.S. wants to build a future-ready infrastructure system, the report recommends an increase in investment from all levels of government and the private sector from 2.5% to 3.5% of GDP by 2025. In comparison to the rest of the developed world, that’s a drop in the bucket, as most are spending seven, eight and nine percent of their GDP according to Lehman, and China is spending 12%. She adds that infrastructure investment is eminently doable. “But you have to have a national imperative. You have to have senior leadership saying ‘This is important. We have to do this.’ We have so many issues and so much investment that needs to be made that we have to unleash everything that we have. And if we do that over a decade, then we can go back to being leaders in the world.”

THE IMPACT ON CRE

So what does all this mean for commercial real estate industrial specialists, especially when considering the ever-increasing impact of e-commerce on logistics? In his recent report, Last-Mile Logistics: Commercial Real Estate’s Growth Engine, KC Conway, chief economist for CCIM Institute, highlights that the last mile is dependent on multiple components of infrastructure, including ports, inland waterways, rail, highways, bridges, energy, aviation, and even levees and storm-water management, and that all must work in synchronization for the last mile of delivery to function at peak efficiency and capacity.

“For real estate professionals that are in the industrial space, if they don’t understand that new connectivity, then they don’t understand where logistics infrastructure is going,” says Conway. And while the ASCE reports expose some harsh realities about the overall state of America’s infrastructure, he is encouraged that the infrastructure most vital to industrial real estate going forward—rail and ports—is also the best maintained. “Everybody wants to move it into the port, put it onto the rail, and get it inland as close to the population as possible, then just truck it for a short distance. And where that is going to be most feasible is where the railroads are connecting to the ports.”

Conway says that that interconnectivity is now having a huge impact on site selection, not only for fulfillment centers for e-commerce giants like Amazon, Walmart, and Home Depot, but also for other large-scale users like auto assembly plants and manufacturers. “Those companies are quickly figuring out where to best deploy capital, and they’re going to locate those physical capital assets where there’s going to be good logistics infrastructure that is up-to-date, being modernized, and not in disrepair.”

One geographic region that Conway expects to benefit from the port-rail connection is something he has dubbed the “Golden Triangle,” a massive swath that extends from the top of the Great Lakes and southwest to Texas and the Gulf Coast forming one side of the triangle, and southeast through Tennessee, Alabama, Georgia, the Carolinas, and Florida, forming the other side. This region is home to 70% of the American population, encompasses five of the seven Class I railroads operating in the U.S., and has more ports than any of the other regions of the U.S. Since the opening of the expanded locks in the Panama Canal in 2015, the number of shipping containers handled by East and Gulf Coast ports has increased dramatically. Conway also notes in his report that the Golden Triangle “now surpasses the West Coast market in virtually every industrial CRE metric, including new construction, transaction activity, and pricing.”

In addition to the ports and rail, the inland waterways could become an increasingly important component of the logistics infrastructure, particularly within the Golden Triangle. One barge tow (15 barges) can transport the equivalent of 216 rail cars or 1,050 tractor trailers, and barge is a “green” alternative to moving product by truck. Unfortunately, the ASCE gives the inland waterways a D+ in its report card, though the Biden administration has called for significant investment in waterways.

“There are two major issues as far as infrastructure on the logistics side is concerned,” says Bryce Custer, SIOR, a broker at NAI Spring Commercial Real Estate in Canton, Ohio and an evangelist for waterways logistics. “One is that a lot of the locks and dams are functionally obsolete, and whenever there’s a shutdown—as we saw in the Suez Canal—on the Mississippi or the Ohio Rivers or any of the major waterways, it slows down product, and at great cost. We’re not investing enough in our locks and dams, but the other issue is the lack of an ongoing dredging program to keep these industrial ports clear for traffic.”

Custer, whose industrial focus has been on development along the Ohio River (Ohio, Kentucky, West Virginia, and Pennsylvania), feels that investment in the waterways could spur significant industrial redevelopment in those states, particularly the repurposing of coal plants that have been demolished. “It’s a great opportunity on the industrial logistics side, because you already have existing infrastructure,” says Custer. “You typically have highway access, you have rail, and many of these sites have barge docks already, so it’s an ideal area for companies to locate.”

But as is with all sectors of the deteriorating infrastructure, it will ultimately come down to funding, which at the time of this writing was still very much up in the air. “We know as a country that our infrastructure needs help and there’s no-one that’s going to question that. Instead, they’re going to question who’s going to pay for it,” says Lehman. “And that’s a step in the right direction. Now don’t kick the can down the road again—do something."




CONTRIBUTING MEMBERS

Bryce Custer, SIOR

 

Media Contact
Alexis Fermanis SIOR Director of Communications
Michael Hoban
Michael Hoban
michaelhoban@comcast.net

Michael Hoban is a Boston-based commercial real estate and construction writer and founder of Hoban Communications, which provides media advisory services to CRE and AEC firms. Contact him at michaelhoban@comcast.net