Latest / Stagflation Conversations with Fexingo: High Inflation, Slow Growth, and 1970s Echoes / Why Stagflation Is Reshaping Industrial Real Estate
Transcript
- Lucas: So there's a story out of Columbus, Ohio that I think captures something weird happening in the economy right now. A mid-size logistics firm — I'll call them Midwest Freight Solutions, not their real name — just signed a 15-year lease on a 350,000-square-foot warehouse. And the rent is 40 percent higher than their previous lease on a comparable space just three years ago. Luna: Forty percent higher in three years? That's not just inflation — that's a structural shift. Lucas: Exactly. And the landlord didn't just bump the base rent. They also wrote in automatic annual escalators tied to CPI. So if inflation stays sticky — and April's core CPI came in at 3.2 percent year-over-year — that rent keeps climbing faster than the company's revenue growth. Luna: Which is the stagflation bind: costs inflate while the economy barely expands. Real GDP grew at what, under one percent annualized in Q1? Lucas: Exactly. Nominal GDP is still growing because prices are rising, but real GDP — the actual volume of goods and services — is crawling. For a logistics firm, that means your revenue is tied to real economic activity, but your biggest fixed cost is now indexed to inflation. Luna: So Midwest Freight is basically betting that they can pass those higher costs on to their customers. But in a slow-growth environment, how many of their clients can absorb that? Lucas: That's the million-dollar question. And it's not just Ohio. We're seeing this play out across the country. Industrial real estate — warehouses, distribution centers, light manufacturing — has been one of the hottest property types since the pandemic. E-commerce and reshoring drove demand through the roof. But now the economics are flipping. Luna: Flipping how? I thought demand for warehouse space was still strong. Lucas: It is, but supply has caught up. A lot of speculative construction started in 2021 and 2022 is just now coming online. Vacancy rates for industrial properties have ticked up from historic lows around 3 percent to maybe 5 or 6 percent nationally. And that's with demand still growing — just not as fast as the new supply. Luna: So you've got more buildings chasing tenants, but the tenants themselves are squeezed by higher rents and slower growth. That feels unsustainable. Lucas: Right. And here's where the stagflation angle gets really specific. Construction costs haven't come down. Lumber, steel, concrete — all still elevated. Labor costs for construction workers are up because the overall job market is still tight. April's unemployment rate was 4.3 percent, and average hourly earnings rose to $37.40. So building a new warehouse costs maybe 25 percent more than it did in 2020. Luna: Which means landlords need higher rents just to break even on new builds. But existing tenants like Midwest Freight are already crying uncle. So who ends up in those new buildings? Lucas: That's the tension. A lot of the new space is being pre-leased by big players — Amazon, Walmart, the big third-party logistics firms. They have the scale to absorb higher rents and the negotiating power to push back on CPI escalators. But the mid-sized tenants, the regional distributors, the manufacturers with thin margins — they're getting squeezed into older, less efficient space. Luna: Or they're being forced to sign shorter leases with more flexibility. I've heard of three-year deals becoming common instead of the traditional ten-year. Lucas: Exactly. Shorter leases give tenants an out if the economy turns worse, but it also means landlords take on more re-leasing risk. And in a stagflationary environment, that risk is real. If growth stays sluggish and inflation doesn't cool, we could see a wave of smaller operators either downsizing or going under. Luna: You know, it makes me think about the barter networks we talked about a few episodes ago. When cash costs get too high, businesses start looking for alternative arrangements. Maybe we'll see more barter or shared warehouse models. Lucas: That's a great connection. And there's already some evidence. I've read about co-warehousing startups — basically WeWork for industrial space — that are popping up in secondary markets. They offer month to month leases with shared loading docks and equipment. Luna: That sounds like a lifeline for smaller firms. But it also shows how the industrial real estate market is fracturing. The big get bigger, the small get creative, and the middle gets squeezed. Lucas: And that's exactly the kind of structural change that persists even after inflation cools. If we ever get back to 2 percent CPI, the lease terms that got written during this period — the CPI escalators, the shorter durations, the higher base rents — they'll still be in place for years. Luna: Right. Which is why I think this episode is useful for anyone who runs a business that ships, stores, or manufactures anything. The cost of the building under your product is changing permanently. Lucas: If today's conversation made something click for you, that's exactly the kind of listener support that keeps this show ad-free. You can help us keep doing it at buy me a coffee dot com slash fexingo. Luna: Yeah, we really appreciate that. Every contribution makes a difference, and there's no pressure — just if you found value in the deep dive on industrial real estate. Lucas: So back to that Ohio warehouse. Midwest Freight's CEO told me they're now looking at automated storage and retrieval systems to cut labor costs inside the building. Because if the rent is fixed by contract, the only variable they can control is how efficiently they use the space. Luna: And automation tech is getting cheaper. We did an episode on factory automation a while back — the cost of robotic palletizers has dropped something like 30 percent in two years. Lucas: Exactly. So you get this feedback loop: high inflation pushes up rent, which pushes tenants to automate, which reduces their need for labor, which puts downward pressure on wage growth in the sector. That's the paradox of stagflation — inflation stays high, but the economy doesn't generate enough demand to support full employment. Luna: And the industrial real estate market becomes a microcosm of that. Landlords with deep pockets and prime locations will do fine. But the rest of the market is going to see more distress, more vacant buildings, and more creative repurposing. Lucas: Some of that repurposing is already happening. I read about a developer in Detroit converting an old automotive parts warehouse into cold storage for food distribution. That's a completely different use — requires different insulation, different flooring, different power supply. But it pays higher rent because cold storage demand is surging. Luna: So the properties that can be adapted to higher-value uses survive. The ones that can't — the generic 1970s tilt-up concrete boxes with low ceiling heights — those might become obsolete. And that's a big deal for municipalities that rely on property taxes. Lucas: Right. And that's a topic we could do a whole other episode on — how stagflation reshapes local government budgets. But for today, the takeaway is: if you're involved in any business that leases industrial space, the rules have changed. The days of stable, long-term leases with modest rent increases are over. You are now negotiating in a world where inflation is embedded in the contract, and growth is uncertain. So you'd better model what happens if CPI stays at 3 percent for another three years and your revenue only grows 2 percent. Luna: And that's not just a CFO's problem. It's a strategic question for anyone who signs a lease. Because in stagflation, the real estate terms you agree to today will determine your profitability for the next decade. Lucas: Exactly. So if you're listening and you've got an industrial lease coming up for renewal, think about the escalator clause. Think about the term length. And think about what happens to your business if the economy doesn't bounce back the way everyone hopes. Luna: I think that's the core insight: in a stagflationary environment, real estate isn't just a cost — it's a risk allocation decision. Lucas: And that's why we're spending time on it. Thanks for listening, and we'll be back with another angle tomorrow. Luna: See you then.