In mid-February, President Obama visited a Master Lock Co. factory in Milwaukee, which has rapidly become the poster child for the trend of “onshoring.”
Since mid-2010, Master Lock, a manufacturer of padlocks and other security products, has brought 100 jobs back to Milwaukee that had previously been off-shored. Obama used the factory to discuss his Blueprint for an America Built to Last, which seeks to incentivize further creation of manufacturing jobs within the U.S. while removing deductions for shipping jobs overseas.
Other, larger examples dot the industrial landscape.
Japanese automaker Honda has plans to invest $98 million in its largest auto engine plant in Anna, Ohio. Heavy equipment manufacturer Caterpillar is opening an 850,000-sq.-ft. facility in Victoria, Texas, in the process of shifting production from Japan back to the U.S. In February, the firm announced it would also shutter a 62-year-old plant in London, Ontario that makes locomotives and move production to Muncie, Indiana.
Other firms, including Ford, General Electric, Coleman, Whirlpool, Cochrane Furniture, Carlisle Tire and Wheel Company and Otis Elevator, have relocated some jobs back to the U.S. or opted to upgrade U.S. plants rather than resort to off-shore operations.
In some cases, corporations are literally reopening factories they previously closed. In others, firms surveying the landscape have opted to open plants in states within the U.S. with the lowest labor costs and unionization rates.
“We don’t think this is a fad,” says K.C. Conway, executive managing director of market analytics with Colliers International. “We are seeing this as a very long-term sustainable trend.”
The effects can be seen in the numbers. Onshoring has contributed to a steady rise in manufacturing jobs within the U.S. since early 2010. Employment in the sector is expanding at an annual pace of roughly 2 percent.
Yet this new burst in manufacturing comes with caveats. Higher productivity means fewer workers need to be engaged in the process to produce the same amount of goods as in the past. So manufacturing as a percentage of the U.S. workforce will remain low. In addition, average wages in the sector have dropped dramatically. That’s part of what’s fueling firms’ desire to relocate.
But it also means the trend will have weaker knock-on effects than one might expect since it will make less of a dent in the overall unemployment rate and today’s blue-collar workers won’t achieve the same kind of spending power as their forebears.
When it comes to deciding where to build factories, corporations weigh several factors: total costs, including shipping and real estate; supply chain efficiency and infrastructure; quality, price and availability of labor; proximity to customers and suppliers; taxes and incentives; and external risks.
“Firms aren’t doing this emotionally,” says Rich Thompson, executive vice president and head of supply chain and logistics solutions, Americas, with Jones Lang LaSalle. “They’re doing it based on all of these factors.”
In the past, cheap labor and shipping costs gave China and other emerging countries a decided edge. That’s now changing. Labor costs are rising rapidly overseas while remaining flat or, in some cases, declining in the United States. Oil prices have been volatile. Brent crude oil’s price remains at more than $100 a barrel. And it’s likely that oil prices—and therefore transportation costs—will continue to rise. Thompson estimates that transportation costs will rise 20 to 25 percent in the next three years.
Moreover, other factors have been in flux. The recession brought with it greater diligence on the part of manufacturers on managing supply chains and inventories and increasingly relying on “just-in-time” production schedules through which goods go straight from factories to shop floors. This reduces warehousing costs and, together with tighter inventory controls, decreases the possibility of producing more goods than can be sold.
In fact, the importance of controlling inventories will become even more important when interest rates rise. Corporations often borrow money to finance the acquisition of inventories and then pay off the interest after those inventories have been cleared. With interest rates as low as they are today, the cost for carrying inventories is low. But in a higher-interest rate environment, there will be more pressure to clear inventories quickly.
Having a supply chain that spans the globe and requires goods to embark on multi-week voyages across the ocean adds risks. If there are delays in production or shipping, firms may not be able to replenish stocks and could be left with bare shelves. This can be especially damaging for seasonal goods where a delay of a week or two can dramatically cut into sales.
And that’s to say nothing of disruptions caused by natural disasters.
“Supply chain disruptions made a lot of companies realize that if they have essential components produced in one country, it could disrupt the entire production process,” says Rene Circ, director of research for the industrial market with CoStar Group. “We saw that with auto production and Japan last year. … The talk of onshoring you hear now is due to supply chain disruption.”
Natural disasters present one kind of risk. Another is political. For example, China, at the end of the day, is not an open democracy. The rise of its economy has come with an increasing number of strikes and protests over income inequality in the country. Closer to home, Mexico has been marred by violence between rival drug cartels and the government, leading to increased leeriness on the part of U.S. firms about operating plants there.
After considering all these factors, what happens when the decision gets made to relocate? In some cases, companies are opening factories that had been shuttered before. That’s the case with Master Lock. But there are also examples of firms bringing jobs back into the U.S. in a different location than where they were before.
“The factory may have been old and outdated,” says Jared Sullivan, an economist with CBRE Econometric Advisors. “The workforce they had before may no longer be there either. So they are going to look to where they can find skilled workers.”
Incentives are a final consideration, but they come last in the decision-making process.
“Incentives matter if you are debating whether to build a plant in Mississippi or Kentucky,” Sullivan says. “But I don’t think those breaks factor into the initial decision of whether to operate in the United States or China. I can’t think of a single example of a corporation saying they moved from China to the U.S. because of a tax deal.”
Trouble in China?
China accounts for about one-fifth of global manufacturing and in 2010 it eclipsed the U.S. as the world’s largest manufacturer. It will likely retain that title and continue to expand its reach. Yet it’s also beginning to face some issues.
Labor costs in China have risen on average almost 20 percent per year in recent years.
In a recent poll of its members, the American Chamber of Commerce in Shanghai found that 91 percent said the biggest challenge they encountered was “rising costs.”
According to global consultancy AlixPartners, three factors are driving rising costs in China: wage inflation, exchange rates and freight fees. Based on the average annual increases in each of those categories, the firm estimates that as soon as 2015 there will be no difference in cost between manufacturing goods in China and the United States.
By another reckoning from the firm, in 2005 goods produced in China and shipped to the U.S. were 22 percent cheaper than products made in the United States. By the end of 2008, the price gap had dropped to just 5.5 percent.
In addition to costs, there are other downsides to production in China that are forcing firms to reassess. One is the nation’s notorious lenience when it comes to enforcing intellectual property rights.
“Many of the intellectual property manufacturers, especially in high-tech, produce something in Asia and then two years later, it comes out in another color locally,” Conway “That’s why they realized they have to come back to the U.S. So about a year ago, we saw an uptick in leasing in office and industrial space, especially in business parks in knowledge gateway centers and education centers.”
The vast distance goods have to cover to get from a factory in China to a destination in the U.S. also introduces risks.
“It’s not a risk that the ship is going to capsize, or anything like that, it is simply the time involved,” Thompson says. “If trends change or if you’re talking about seasonal goods or equipment, even a small delay can really hurt you. It’s easier to manage your kids when you can see them than if they are at their friend’s house.”
Moreover, there are quality control concerns about goods produced in China. In recent years there have been scares involving tainted toys, seafood, pet food and other products.
The concerns about intellectual property and quality control are especially acute in industries like pharmaceuticals, according to Rakesh Kishan, president of UMS Advisory, a management advisory firm that consults corporations on outsourcing.
“Pharmaceutical firms want to make sure that their drug product is not in some way contaminated or produced in a way that is not up to [U.S. Food and Drug Administration] requirements,” Kishan says. “That is a concern for some companies and may shape their decision to keep production on domestic soil.”
Lastly, conditions at Chinese labor factories are stark, which could hurt the image of an American firm.
For example, Apple has been dogged by criticism because of the reportedly brutal conditions at the Foxconn plant in Longhua, Shenzen, which employs between 230,000 and 450,000 people (according to various accounts.) Foxconn serves Apple, Dell and HP and has become the focus of scrutiny after a rash of suicides between 2010 and 2011. The firestorm led to Apple recently conducting a probe into the working conditions at the factory to dispel criticisms.
Contrary to popular belief, U.S. manufacturing never really went away. The U.S. produced 18.2 percent of all goods globally in 2010, amounting to $1.86 trillion, according to United Nations data. However, 2010 did mark the first year since the late 1800s in which the U.S. was not the largest producer. China, with $1.92 trillion in manufacturing output, took the crown.
Still, nearly $2 trillion in output is nothing to frown at. It’s more than Japan, Germany, Great Britain and Italy produce combined.
Two factors have contributed to the notion that the “U.S. doesn’t make anything anymore.”
Firstly, the U.S. does not produce the kind of finished goods that come with “Made in the U.S.A.” labels. The majority of consumer goods are produced in China. What the U.S. specializes in is heavy machinery and goods that are the product of highly-skilled labor. Automobiles, airplanes, aerospace components, pharmaceuticals and semiconductors are all sectors where the U.S. retains a large share of world production.
Secondly, the percentage of the labor force engaged in manufacturing domestically has dropped dramatically. The U.S. manufacturing labor force peaked at more than 19.5 million jobs in 1979 and has fallen to about 11.9 million jobs—roughly a 40 percent decrease, according to the Bureau of Labor Statistics. Manufacturing used to account for 25 percent of the workforce. Now it is just 8 percent.
But it’s not because the U.S. produces less stuff. Manufacturing output peaked in 2007 and fell as a result of the recession. In recent months, it’s climbed again.
What’s happened is that in the last 40 years, productivity has skyrocketed. Output per worker in the manufacturing sector has grown 136 percent since 1987—more than double the 63 percent increase in output per worker for the U.S. economy as a whole, according to CRE Econometric Advisors. According to William Strauss, senior economist at the Federal Reserve Bank of Chicago, what it took 1,000 workers to do in 1960 requires only 184 workers today.
That’s what makes the recent rise in manufacturing especially encouraging. In spite of productivity gains, the manufacturing sector has stopped shedding jobs and has been adding them. Since bottoming at about 11.5 million workers in January of 2010, the U.S. economy has added 421,000 manufacturing jobs. The sector is growing at an average annual rate of about 2 percent—the fastest rate of expansion since the mid-1990s.
The rise in manufacturing jobs means that some of the counties adding jobs the fastest are in “Rust Belt” states—an area that’s pointed to as evidence of the decline in U.S. manufacturing. For example, employment in Detroit grew by 2.2 percent from 2010 to 2011—making it the seventh-fastest growing market in the country, according to the Bureau of Labor Statistics. Pittsburgh ranked 10th. Other fast-growing counties include counties in the South, where some manufacturers have chosen to locate.
So production never disappeared. But there are factors that are strengthening it, including a lowering of wages for manufacturing employees.
Real hourly wages for U.S. manufacturing employees have remained flat since 1970. In 2000 dollars, average wages were $14.35 an hour in 1970 and $14.63 in 2009, according to the Bureau of Labor Statistics.
In the case of Caterpillar, workers at the Muncie plant, where it is shifting production, are paid $12 to $18.50 per hour—half the $35 per hour rate their Canadian counterparts were earning. Unit labor costs in the U.S.—wages and benefits paid per dollar of output—have also fallen relative to markets besides China, including Germany, South Korea and Canada. Overall, Caterpillar is planning to invest 60 percent of the $4 billion it has set aside for capital spending in 2012 in the United States.
Indiana is one state that recently enacted right-to-work legislation that prohibits agreements between unions and employers to create “closed shops” and limits auto-payment of union dues. Closed shops are workplaces where every employee must belong to the union as a condition of employment.
Currently, 23 states have some sort of right-to-work laws in place, many of which are in the South. But that’s just one part of the region’s allure. Real estate costs are lower in the South and space is more available. There are greater taxes and incentives available in that region. And the more temperate climate leaves less chance of weather-related disruptions.
Additionally, roughly two-thirds of the U.S. population lives on the East Coast. If a firm is producing goods for domestic consumption, the geographic proximity to customers is a benefit. And if the goods are meant for consumption overseas, then the firm is close to the East Coast ports, which will receive an additional boost after the Panama Canal is widened and deepened, increasing the East Coast’s connectivity to Asia.
Besides costs, there is a difference in labor quality in the U.S. as well. “Many of the manufacturers coming back from Asia and India say the quality control there is atrocious,” Conway says. “We have quality control, a well-trained work force. It’s much more robust here than in Asia.”
Lastly, there is increased talk of improving U.S. infrastructure, which will cheapen the cost of moving goods around the United States. President Obama has proposed creating an infrastructure bank in the past. His “blueprint” presented this year also proposes spending $476 billion through 2018 on highways, bridges and mass transit projects, $47 billion over six years to build up a high-speed rail network; and more than $1 billion in fiscal 2013 for the Next Generation Air Transportation System.
However, some question whether those ambitious plans will take shape.
“I am a little skeptical of the government’s ability to encourage onshoring,” says Robert Bach, senior vice president and chief economist with brokerage firm Grubb & Ellis. “To the extent they can provide tax breaks or lower taxes that could help.”
What it all means
The implications from all this for the U.S. commercial real estate industry is that it strengthens the outlook for the industrial sector, but not as dramatically as it might seem.
As it stands, the industrial sector enjoyed fairly stable fundamentals into and out of the downturn. The total industrial market vacancy rate stood at 9.5 percent at the end of the fourth quarter of 2011, according to CoStar. It declined in every quarter of 2011 and is down a full percentage point from its recessionary peak of 10.5 percent at the beginning of 2010. For flex space, vacancies are a bit higher—12.6 percent at the end of the fourth quarter—but there too the rate has declined from a peak of around 14 percent in 2010.
Developers are also remaining cautious with new construction. Currently, CoStar is projecting just 29.7 million sq. ft. of deliveries in 2012. The number in 2011 was 49.1 million sq. ft. and the 30-year average is 230.3 million sq. ft. The 2012 figure could change, however, given the shorter development lead times for the sector. Projects often take around six months to build, so some properties that will come online in 2012 are not yet under construction.
The lack of an impact on the industrial sector is primarily because while there are examples of onshoring that exist, it is not something companies or industries are doing wholesale. Sectors that produce smaller goods that carry lower shipping costs—such as ones that produce microchips or circuit boards—will be less likely to consider onshoring. Low value-added sectors that rely on low-skilled labor won’t benefit as much either.
Secondly, the rise in manufacturing is contributing to a lower unemployment rate, which is a positive macroeconomic trend. But the increased productivity of U.S. workers means that all the jobs eliminated in the sector will not be added back. “It’s going to be accretive, but not a tsunami of jobs,” Kishan says.
And the lower wages being paid for these jobs means a limited boost for consumer spending.
In addition, many of the corporations that are making decisions about onshoring tend to own and operate their manufacturing facilities internally. So in many cases, it won’t create additional opportunities for industrial real estate owners and developers.
“Manufacturing space tends to be very specialized and often manufacturing companies build their own buildings and they don’t need to buy the space that existed previously,” Circ says. “It would most likely be owned by the manufacturer because they are making a long-term commitment and they want to control that real estate.”
The exceptions to this might be smaller secondary and tertiary suppliers that support larger manufacturers. Those kinds of firms tend to locate in flex space.
There also could be some reconfiguration within the U.S. of stronger and weaker industrial markets. Moving production of goods that are consumed in the U.S. to the U.S. will affect the supply chain and the 185 public U.S. ports. That will shift some of the demand for warehouse space to the Midwest from the East and West Coasts.
The upshot of all of this is thatonshoring is not just hype. It is a real dynamic to reckon with and is likely to continue. But its effects will not dramatically alter the course of the U.S. economy or of the commercial real estate sector as a whole.