CBRE Torto Wheaton
January 16, 2009 Volume 10, Number 2
by Luciana Suran, Economist firstname.lastname@example.org
Something struck me when was watching The Ascent of Money, a great documentary (and book) about the history of money, last night on PBS. The film's narrator, Niall Ferguson, devoted a considerable amount of time comparing the current downturn to recessions of previous years, such as the Great Depression. As a fellow (though, ahem, considerably less famous) economist, I often wonder about the same thing. I'll be honest: seeing the images of severely malnourished people during the Depression (don't forget how real GDP fell by 30% back then), I didn't find much validity in the argument that our current predicament is akin to the Great Depression.
But I do think we can learn something about the current downturn in industrial real estate by comparing the present recession to the one that occurred in 2001—at least with respect to its effect on industrial real estate. On the surface, our current recession appears to be quite similar to the previous one. Demand is falling, availability rates are rising, and industrial rents have declined. Our 4th quarter industrial data recently arrived and—surprise!—things aren't looking so hot. Net absorption plunged for the fourth quarter in a row as the market shed almost 48 million square feel of industrial space—the biggest decline since the second quarter of 2001. Our TWR Warehouse Rent Index finally declined for the first time since 2005, falling nearly 4% (annualized) from $6.09 to $6.03.
That said, there are certainly many differences between the two recessions—most notably the causes, which in this case are, so far, affecting industrial markets differently. The 2001 recession was largely the result of the high-tech boom and bust. The R&D sector was particularly hard-hit and R&D facilities experienced larger increases in availability compared to manufacturing and warehouse/distribution facilities. Markets with high concentrations of high-tech businesses—such as San Jose, San Francisco and Austin—were among the worst performers in terms of rent decline. But the 2008 recession, with its genesis in the financial crisis, was slow to affect high-tech markets; consequently, many of the markets that performed poorly in 2001 are among the top performers in the current recession. San Jose, Dallas, Fort Worth, and Columbus all experienced rent declines in 2001 but have made sizeable gains in 2008, despite the declining economy. And don't forget the Texas markets, all of which have made the top ten list in (don't say we didn't warn you).
The Winners and Losers Are Different This Time Around
Source: TWR Industrial Outlook XL, Spring 2009 (preliminary estimates).
The situation is different this time around in another way. The biggest jump (190 basis points) in availability has been among warehouse/distribution facilities. Furthermore, many of the markets that enjoyed positive rent growth in 2001—like Phoenix—have seen rents plummet. Why is this, you ask? Warehouse and distribution centers exist for one simple purpose: to store and distribute goods. In the years preceding the current crisis, many Americans used their home equity like ATM machines and consumer spending surged, which helped support economic growth. Demand for warehouse space surged, especially in coastal port districts like the Inland Empire, which were on the receiving end of a flood of imports from Asia. Likewise, industrial rent growth also rose in markets in the midst of the housing boom. Just three short years ago, Miami, Tampa, Orlando, and Las Vegas were among the top ten markets when it came to industrial rent growth. Since then it's pretty much been a race to the bottom for these same markets.
Now that we're in a recession (and are experiencing an unprecedented tightening of the credit markets), consumers and businesses are demanding far fewer goods. Lower demand for goods means lower inventories, and lower inventory means less demand for warehousing and distribution space. In 2001, the high-tech bust sharply reduced the need to make all these tech-related goods and manufacturing inventories plummeted, falling more than 9% during the 2001 recession. Retailers and wholesalers drew down their inventories as well, but at a much more modest rate of 3%. The inventory picture is quite a bit different this time around. The retail sector has been responsible for the vast majority of the inventory slowdown in this current recession. The pace of growth of retail inventories began to fall sharply well before the current recession began in December of 2007. Wholesale and manufacturing inventories continued to grow until just two months ago, as the global economy plunged into a deep—and most likely prolonged—manufacturing slowdown. We can definitely expect manufacturing and wholesale inventories to drop in the coming months, but you can blame the retail sector for the inventory slowdown of the past year.
Blame Retail for the Inventory Slowdown
Source: U.S. Census Bureau (shaded areas denote recessionary periods as declared by the National Bureau of Economic Research).
So don't assume this recession will affect the demand for industrial real estate like it did in 2001. Pay attention to what drives the differences in industrial demand on a market-by-market basis; many markets are now more fully integrated into global supply chains that will hold upside potential when the recovery takes hold and may act as a buffer for some markets during the downturn. We are still expecting further declines in rent for most markets, but some will fare better than others. Inland markets that were relatively unscathed by the housing crisis should outperform the national average. Export-dependent markets will most likely continue to outperform many of the larger import-dependent markets, despite the latest trade data showing worrisome declines in export activity.
And last but certainly not least, Niall, if you happen to read this…can I be your assistant for your next documentary? I've always wanted to get into film!
Copyright CBRE Torto Wheaton Research 2009. Used with permission.