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Q&A with David Egan: Industrial in a Recession

NAREIM Dialogues, Fall Issue

Current market turbulence has left investors with questions about what this moment means for the industrial sector. Its dramatic evolution over the past few cycles – largely the result of rapid e-commerce growth – offers several lessons and opportunities that can insulate the sector from total disruption. David Egan of Stockbridge dives into how the sector performs in a recession and future opportunities.


How does industrial typically fare in a recession?

Industrial, as an asset class, tends to track closely with the economic cycle. As the economy slows, demand will typically follow, often lagging a quarter or two. Looking back at data over the past few decades, we can see a tight correlation between GDP and demand (see Exhibit 1).

This cyclical trend has typically been most evident within warehouse, especially big box. Demand in this space is largely tied to consumer consumption.

A shift happened in 2012 when e-commerce erupted and really took hold. Faced with delayed shipments to consumers around the holidays, Amazon made the leap to take their entire delivery process in-house and, with that, changed the very nature of its business from price-oriented to become inherently service-oriented. This move is what ultimately drove broad e-commerce adoption.

According to CBRE Research, the e-commerce share of total retail sales roughly tripled from 3.8% in 2009 to 11.3% at the end of 2019. The pandemic also caused a dramatic change in consumer behavior, which drove e-commerce to comprise 16.1% of total retail sales in 2020. With the onset of Covid-19, the on-demand economy broke; it became crucial for suppliers to store excess inventory within warehouses and big-box spaces for ‘just-in-case’ situations like ports shutting down and ongoing delays.

Due to e-commerce and changing consumer expectations for speed of service, the amount of real estate needed to fulfill this rapid movement of goods has greatly exceeded what economic trends suggest. CBRE data shows that since 2013, users have absorbed an annual average of 115 million square feet more than GDP has predicted. However, as the growth of e-commerce has not yet plateaued, we expect user demand will outpace the typical demand generated by economic output, largely due to e-commerce growth and inventory needs.

What we have experienced historically tells us we are likely to see a slowdown in the sector, though it will be less directly related to economic turmoil. Eventually, e-commerce supply chains will be largely developed, so the need for massive and rapid growth will decrease, resulting in demand drivers returning to more typical factors, such as GDP, employment and production.


What can we learn from previous cycles?

People often think of industrial in a holistic sense, but viewing the sector this way can be counterproductive and often dangerous. The sector is a collection of different types of properties, with different uses, in a wide variety of markets. Factors that affect one property type or market may have little or even the opposite effect on another. Understanding what those differences are is critical in times of disruption.

To conduct a thorough analysis of the sector, it is important to examine the market fundamentals first and foremost since the key fundamentals – vacancy, rental growth and new supply – will always lead the way and offer insights as to what may be coming. Viewing the market and product type in a much more granular way results in far more potential opportunities.

Following the Great Financial Crisis (GFC) in 2009, industrial was largely viewed on a grand scale. Many shared the belief that the entire sector was struggling, and, as a result, missed out on opportune investments. Low vacancy markets like Southern California, the Bay Area and New Jersey, were either only slightly affected by the downturn or bounced back significantly quicker than others. While other markets collapsed, demand in these markets remained stable and the markets outperformed in infill locations. While big-box new development was a cause for concern, the low vacancy rate coupled with rebounding demand, made the recovery in these markets swift. Any investment thesis that ignored the general panic and negative headlines around the GFC would have performed exceptionally well – this is certainly an important consideration today.

We can also learn a lot from previous cycles in terms of supply versus demand. In any downturn or recession, supply indicates how much the cycle really fluctuates. It is crucial to track supply rather than demand and to understand what the components of supply really are.

Read the full article via NAREIM.