Industrial Recovery Is Underway

Looking at market fundamentals, the industrial real estate market appears to be in the deepest hole it's ever been in. CBRE-Econometric Associates (formerly TWR) states that the current warehouse vacancy rate was 14.5% at the end of 2009, an increase of 2.7 percentage points from the previous year. This level is by far the highest vacancy has ever reached. Tenants vacated (or more accurately, never occupied) large amounts of space that they leased in the 2005-2007 period. Since total occupied space peaked in 2007, net absorption has totaled -203.5 million square feet. Rents have fallen 11% from their peak and are expected to fall another 7%, as landlords cut rate to fill their space.

Notwithstanding the current gloom, there are signs of hope emerging. Most leading indicators that drive warehouse demand have turned positive, some in dramatic fashion. The two indicators that have the biggest impact on the industrial sector are trade and manufacturing output. January imports were 13.7% higher than they were a year earlier (though still 25% below the peak in mid 2008). In response to massive fiscal stimulus, GDP growth is responding as well, with growth in the past two quarters measuring 2.2% and 5.9% respectively.

Other indicators indicate that industrial demand will strengthen as well. The Institute for Supply Management's Purchasing Managers Index (now at 56.5) has been above 50 for 7 months. Values above 50 are consistent with a growing economy. Industrial production is also rising. February production was 1.7% stronger than in February last year.

There is still quite a bit of slack in the supply chain. Firms are underusing the space they are currently in. Consequently, the economic improvement won't translate into an immediate rise in industrial demand. Rather, we are likely to see a stabilization of demand in much of 2010. Negataive demand early in the year will be balanced by stronger demand in the second half.

A much stronger pace of industrial real estate demand growth will have to wait until 2012, however. Rents will stabilize this year and grow slightly in 2011. Rent growth will probably be in the 4-5% range in 2012 and 2013, as efficient distribution becomes more scarce.