Where does industrial go during the next recession?
The GFC created such widespread mayhem that no asset class survived unscathed. Fast forward 13 - 15 years and we’re now in a different place with industrial emerging as one of the most highly desired property type for investors. Many markets, in particular those in Hawaii, are edging on 0% vacancy and continue to see lease rents rising in response to unrelenting demand. Other markets, with quicker entitlement processes, readily available land to develop and moderate construction costs (compared to Hawaii), have seen lease rents boom in the last 5 years and in many cases double. But as the boom slows, these markets appear vulnerable to slowdown as new supply continues to hit and businesses slow their expansion plans in the face of rising recession risk.
For all markets, the biggest change to industrial use since the GFC has undoubtedly been e-commerce. Retail has been crushed by online shoppers and the importance of a solid distribution network has never clearer as consumers demand goods delivered next day or sooner. Second to e-commerce, might be the last mile warehousing phenomenon necessitated by supply chain disruptions and internet shopping demands, and the growing presence of wholesalers gobbling up industrial space. It would be great to see an actual chart verifying this comment, but it’s my guess the mix of industrial users have shifted, along with consumer habits, towards more distribution / wholesale and away from a broader mix of everyday businesses like construction, services and suppliers. Part of this is the impact of new construction of distribution centers, the other part being change in industrial use in recent years.
If I’m right in my assumption, does this make us more or less vulnerable during the next recession?
In select markets heavy with Class A distribution from players like Amazon, the effects of late stages cycle economics is already playing out via softening rents. The oncoming recession has been so well telegraphed that businesses have now had 2+ years to prepare as recession forecast continue to push out. In markets like Hawaii, where land and space is scarce, rents and occupancy continues to tighten. It’s now at a point where available space is so precious in Hawaii that I would guess any business affected by a recession would have to think really really hard about giving up their space knowing how nearly impossible it would be to re-occupy industrial in the coming years. Other than being pushed to the brink of bankruptcy, like some did during the GFC where vacating is the only option for a business, I think the challenging backdrop of markets like Hawaii will be the primary reason we see rents and vacancies remain stable during the next recession.
But won’t rents fall somewhat? Mostly likely, yes. In simple analysis, markets with a large presence of big-box distribution and excessive new supply coming, will likely see rents soften, say by 5 - 15%. Distribution is tied very closely to economic activity, yet boosted oppositely by the consumer trends developed post-pandemic. Unfortunately, the tug-of-war between these opposing forces collapses when a wholesale economic crash occurs. In markets like Hawaii with an emerging push into Class A distribution from the likes of Amazon, Costco and Home Depot, and extremely low vacancy, rents may stay flat or decline 5% with a lack of new supply serving as the floor for occupancy.
It’s hard to say this time will be different except for the extreme industrial shortage seeing across our state. In 2008, vacancies were around 1% going into the GFC, topped out around 5% in 2011 and fell below 2% by the end of 2014. As vacancy rose during this time, the top-to-bottom change in rents was nearly 25%. There’s a historical playbook to follow, which is why it’s critical to pay attention to the changing trends in industrial use since the GFC, and more recently the pandemic, to see how this time might be different.