Week of October 12, 2020

Are Recessionary Conditions Returning?

We are well into the sixth or seventh month of the virus and even with a bounce back from the worst, recessionary conditions are here. Despite Industrial being the best of all commercial property types and the good performance of ecommerce, there is softness throughout. During a recession, there are distinct market differences how to operate.

Pre-Covid, space was so tight it was called negative absorption. There were three tenants for every space. Tenants feared they would be caught short without a location and paid the asking price with no free rent. Now there is space available. Lots of buildings in Carson and Compton. Torrance has supply. And LAX, a notoriously tight market, has units available.

A few distinctions. Well located distribution buildings with good loading are rewarded with rising rents, low cap rates, and high prices. These buildings are suitable for ecommerce. Generally, ecommerce buildings are larger, have lots of dock-hi doors, and high ceilings. They are close to consumer density or near critical logistics infrastructure of airports, ports, inland ports and freeways. Ecommerce is a growing segment, related to the rise of the internet and containerization. In contrast, the majority of industrial buildings are smaller; designed for manufacturing and service; and are generally older with less functional loading. It is the second type of buildings that are more prone to recessionary conditions.

What is the recessionary playbook? A shortage of tenants, prices come down, and buildings stay vacant for an extended period. I’ve been intrigued by a piece of research that we are closely monitoring called the Price Dynamics Platform “PDP” (http://pricedynamicsplatform.mit.edu/). The PDP forecasts lower prices in almost all categories and although industrial is the best situated, there will be drops. Similar to previous recessions, tenant demand slows, markets stall, and to make transactions, sellers will drop their prices.

This sets up a market dichotomy. Institutional investors are competing hard for ecommerce buildings to add to their holdings. For this segment, cap rates are at their historic low and prices are rising. In contrast, almost all other industrial properties follow the weak economy and expectations will be adjusted.

Currently, prices are generally holding but terms are more liberal. They key determinant will be if inventory levels continue to grow. One big thing owners can do is get your buildings looking good and ready for move-in. Copy the professional landlords. Have patience because you will find your deal.