Economist's Commentary: October 3, 2008

Industrial Market Trends

By Danielle Hale, Research Economist

Industrial sector completions in the first half of 2008 were a robust 79 million square feet, essentially unchanged from completions in the first half of 2007. Furthermore, this year's first half completions exceed first half completions for 2003-2005. The supply side of the industrial sector is therefore abundant.

By contrast, net absorption, the primary measure of demand, turned negative in the first two quarters of 2008. Because net absorption has not kept pace with the industrial space coming online, the vacancy rate has risen to over 10 percent.

Net absorption is expected improve to 14.6 million square feet this quarter on the strength of vigorous exports, but completions are also projected to continue to grow. Expected industrial completion for the third quarter is 47 million square feet, an increase of 8.9 percent over what was finished in the third quarter of 2007.

Because completions are outpacing absorption, the vacancy rate is expected to rise further to 10.5% in the third quarter 2008. Flush supply and a rising vacancy rate make it difficult to extract more income from properties. For this reason, rent growth is projected to be flat, at zero percent, for the third quarter 2008. As completions continue to outpace net absorption, vacancy rates will rise and downward pressure will build on rents. They are expected to decline by around 0.3 percent in the last quarter of 2008 and first quarter of 2009.

The major industry sectors driving performance in industrial sector commercial real estate are distribution and manufacturing. While some economists and analysts have lamented the effect of a weaker dollar on capital flows, a weakened dollar has been a big boost to exports and by extension the distribution sector. Distribution jobs continued to grow through the first quarter of 2008 and only began to decline in the second quarter. While this decline is expected to persist in the third quarter the number of expected jobs shed is small and the pace of the loss is projected to slow. By contrast, a decline in manufacturing jobs began long before the current crisis and has persisted. President Bush's approval of reduced interest rate loans for auto makers at the end of September may help stem the losses in that sector, but these loans may not be available until mid 2009.

The forces driving performance play out quite clearly in a look at the geographical distribution of market performance as measured by vacancy rates. Because vacancy rates are influenced by both supply- and demand-side pressures (completions and net absorption respectively), they are a good snap-shot indicator of the market.

The following table shows that low industrial vacancy rates are found in the West in areas that have seen a moderate increase in industrial space completion and that have relatively stable manufacturing and distribution industries thanks to their involvement in international trade. By contrast, in Midwest and Northeast areas such as Boston, Baltimore, Columbus and Detroit, losses in the manufacturing sector have not been fully offset by stabilization or gains in distribution and completions have outpaced absorption. Improvement in vacancy rates for these areas depends on a pick-up in the economy which may come if auto makers take advantage of the government loans.

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