NAIOP’s most recent Industrial Space Demand Forecast (“Forecast”), released in August, projected a sharp decline in net absorption for the third quarter, to negative 141 million square feet. According to data provided by CBRE, the actual industrial net absorption in the third quarter was substantially higher at 67.7 million square feet. Past iterations of the Forecast have been largely accurate, so why the miss? Part of the answer lies in how consumers shifted their behavior in response to the pandemic.
This entry draws from discussions with Timothy Savage, Ph.D., and Hany Guirguis, Ph.D., the authors of the Forecast, and NAIOP Research Foundation Governors Douglas Swain and Lewis Agnew, to examine why the third-quarter forecast underestimated demand. As industrial developers, Swain and Agnew were able to offer an on-the-ground perspective on the leasing market, providing additional insight into the trends that are currently shaping demand for industrial space.
Pandemic’s Economic Impacts Hard to Predict
The coronavirus pandemic’s effects on the economy are unprecedented, which has made forecasting future demand for all types of commercial real estate more difficult. Predictive modeling relies on identifying relationships in known data to predict future conditions. The model underlying the NAIOP Industrial Space Demand Forecast is based on an analysis of leading economic indicators and quarterly real estate market data provided by CBRE. However, the data used in the model, which date to the early 1990s, do not include a record of a major global pandemic, making the task of projecting COVID-19’s effects on industrial real estate more difficult.
The macroeconomic predictions that Savage and Guirguis made for the third quarter proved to be largely accurate. The challenge for the Forecast is that leading economic indicators were less predictive of industrial demand than they have been in the past. The current recession is different than most in several ways: recessions are usually less abrupt and less severe, and they usually reduce demand for most types of commercial real estate as businesses and consumers reduce their expenditures and lenders and investors grow more cautious.
As in past recessions, consumers have reduced their overall expenditures. However, unlike past recessions, consumers’ safety concerns have led them to redirect their spending away from services and toward goods. Buoyed by stimulus checks and supplemental unemployment benefits, total consumer expenditures on goods in the third quarter not only increased over the second quarter, but exceeded the previous peak in goods expenditures (in the fourth quarter of 2019) by 6.7%. Consumers also shifted more of their purchases online, with ecommerce expenditures up 36.7% year-over-year in the third quarter. However, this trend was not yet apparent when the last Forecast was released. The third quarter had not yet concluded, and data from the second quarter showed a significant drop in consumer expenditures on both goods and services, as has occurred in past recessions.
Effects on Demand for Industrial Real Estate
Like consumers, industrial tenants have also responded to the current recession differently than in the past. After spending the first weeks of the pandemic responding to supply chain disruptions and assessing the coronavirus’ effects on the economy, many retailers accelerated the expansion of their e-commerce distribution channels to bypass closed stores and reach consumers who had safety concerns about in-person shopping. However, many of these plans had to wait until government restrictions on travel and business activities eased.
Douglas Swain, vice president and general manager of Opus Development, observed that leasing activity slowed in the first months of the pandemic in part because prospective tenants were unable to travel to tour properties and sign new leases. Swain saw industrial leasing and development activity in the Ohio and Indiana markets begin to pick up again in the summer, and by September, deal activity had increased considerably.
Lewis Agnew, president of Charles Hawkins Company, observed a similar trend in Nashville and surrounding markets. His firm received a flurry of rent deferral requests early in the pandemic, and tenants supporting events and the entertainment industry, such as party and sound equipment rental companies, have struggled. Nonetheless, his firm’s industrial rent collections never dipped below 97%. More recently, there has been strong demand for industrial properties in both Nashville’s central business district and for speculative properties on the outskirts of the city. “There was certainly a slowdown, but then e-commerce is just the wind beneath the sails,” Agnew said. “For every tenant that has slowed down or needs rent relief, there is another that needs more space.”
Swain is unsure whether the recent increase in activity is a result of retailers and logistics firms responding to changing consumer demand. It may also be that the increase in activity is from firms catching up with expansion plans that had been temporarily delayed during the first months of the pandemic. “The next few quarters will be telling.” Either way, he is optimistic about near-term and long-term demand for industrial space. “What we are seeing right now is very strong. I wish I had five more buildings up.”
Swain and Agnew both observed that industrial space had been in short supply in their local markets prior to the pandemic, and that an abundance of tenants looking for industrial space likely helped to cushion leasing markets from the pandemic’s immediate effects. Swain noted that unlike the 2008 recession, when market participants were uncertain about future demand, developers, lenders and tenants have generally viewed the pandemic as a short-term disruption that is unlikely to significantly impede long-term demand for industrial space. Agnew expects that the acceleration of e-commerce due to COVID-19 will be a positive for industrial markets over the long term, as consumers pick up new habits.
It may make sense to adjust the model used in future editions of the Forecast, depending on how the economy and the industrial real estate market perform in the coming months. It remains to be seen whether the relationship between leading economic indicators and demand for industrial real estate will continue to diverge from past established patterns. If demand for industrial space continues to be less sensitive to fluctuations in the broader economy than it has in the past, the model may need to be adjusted accordingly. On the other hand, if demand trends associated with the pandemic dissipate as the pandemic recedes, the existing model may again prove to be highly accurate. Going forward, Savage and Guirguis will continue to monitor the economy and available data on industrial demand, and will seek input on current market conditions from the development community.
As NAIOP Research Director, Shawn Moura manages the NAIOP Research Foundation research committee and day-to-day operations of the Foundation’s research projects.