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Navigating the Industrial Market During a Triple Threat

Jul 16, 2023
Boris Duric
Devin Roundtree

In this Solution Session, EisnerAmper and TAG Industrial discuss the current state of commercial real estate’s industrial market and what lies ahead, given everything that transpired in the first half of 2023. The session will also cover how industrial investors, owners, and users can benefit from the current market, and why Texas specifically might be well-positioned to handle an economy that is in flux.


Boris Duric:

Hello, I'm Boris Duric, an Audit Manager in the Real Estate and Construction Services group at EisnerAmper. Today, I'm joined by Devin Roundtree, Research Analyst at TAG Industrial, a leading sales team in the industrial real estate market and [inaudible 00:00:13]. Devin is the author of TAG's industry report titled Industrial Watch, which is published twice a year. Today, we'll discuss the current state of industrial development and what lies ahead. We'll also cover how investors, owners, and users can benefit from the current market. Devin, thank you so much for joining me today. To start off the conversation, can you give us a recap of what we've seen in the industrial market so far in 2023?

Devin Roundtree:

Hey. Thank you, Boris. Thank you for having me. Coming into this year, we stumbled coming out of last year really. When it comes to sales activity, the number of transactions that we saw during the fourth quarter of last year were the lowest since 2011. During the first quarter of this year, sales transactions were lower by 2013 first quarter numbers. It was a bumpy ride, and this is something that we thought was going to happen. What we put out in our industrialized magazine last summer was that because of Federal Reserve raising interest rates, we knew that it was going to impact the industrial market because of how sensitive the industrial market is to higher interest rates. It wasn't a surprise that we saw a big drop. Now, so far this year, it is not just about sales activity, it's also about the market fundamentals that's going on the decline as well.

I'm talking about absorption rates, I'm talking about vacancy rates, I'm talking about deliveries. Now, nationwide, we're seeing everything take the wrong trend. Go back to the second quarter of last year, we hit a record low in the vacancy rate, about 3.9%. As far as this second quarter is concluding, we're up close to 120 basis points estimated to about 5.1%. Now, we thought going into this year, we were going to start to see a divergence between big-box warehouses. I'm talking about the Amazons of the world and small industrial properties. So far, that's played out, but for very different reasons. I want to take a look at big-box first. We define big-box properties as properties, over 200,000 square feet. We're seeing that vacancy rate rise 190 basis points year over year to 6.1%. That's a very noticeable increase. Now, what's driving the big-box vacancies are actually speculative over building.

Earlier last year, that was thought as [inaudible 00:02:38] impossibility. That impossibility is not a reality. We're building way too many Amazon warehouses. The market can't absorb it all. Now, on the other end of the spectrum, small industrial properties, we define that between 10 and 50,000 square feet. We're seeing a small but so noticeable increase in vacancies year over year up 50 basis points, so much lower than a national average. Now, good news is that you don't have to worry about new supply. There's virtually no new supply, especially specialty supply on a smaller end. However, demand is falling. When you look at net absorption, year to date is at the lowest levels since the Great Recession days of 2009. Overall, when you take a look at the whole market, you look at supply, you look at demand, those gaps, you look at how much vacancy rates are rising, we're in the worst shape right now since the Great Recession. Unfortunately, I believe that the industrial real estate market is already in recession.

Boris Duric:

Devin, you've already touched on one of these points, but at EisnerAmper, we talk a lot about the triple threat facing the commercial real estate world. You've got high inflation, rising interest rates, and a looming recession. How do you see the industrial market being impacted by these threats?

Devin Roundtree:

Yes. Well, before I get into how this triple threat is going to impact the industrial real estate market, I really want to take some time and go over each of these triple threats. Because you look at what we've been hearing from all the experts out there, the financial and economic experts out there over the last couple years, they've all downplayed all of these threats and they've been surprised again and again and again. But here at TAG Industrial, we're one of the few people out there in the commercial real estate world, we've seen this formation of the triple threat coming. We didn't downplay. We took all these stuff serious. I want to start out with inflation. Two years ago, summer 2021, what would all the experts saying then at that time? "Inflation is transitory. We don't have to worry about it.

It's just the economy reopening. The ports are backed up, supply chains. Don't worry. Once everything gets back to normal, prices is going to come back down. We're good." Well, that didn't happen, and then it kept on trying to predict when prices had peak, those month after month. October came 2020, "Oh, prices peaked. November, December, prices peaked. Prices peaked." During this entire time, we saw prices continuously rising faster and faster and faster. Well, we never bought into the whole transitory argument. We were saying that inflation was bad. It was going to stick around and it was going to get worse. The reason why we said that is because we had a different lens on. We were looking at inflation from the historical understanding of inflation, which has nothing to do with prices, but actually the expansion of the money supply.

That's the original definition of inflation. 2020, 2021, what happened? The Federal Reserve blew up the money supply by over 40%. That's the largest amount on record. It wasn't a surprise that prices took a while to catch up to all those price increase, to all that inflation. It wasn't a surprise. We knew it was going to last well past the issues on supply chains. Now, with regards to the issue of interest rates, last summer, the Federal Reserve started to more aggressively hike interest rates. What were experts saying then? "Oh, we're just going to have a soft landing. No recession. No financial crisis. Everything's going to be okay. We're just going to have a soft landing. Maybe a little uptick in unemployment. That's about it." Well, we knew, at the time, we weren't going to have a soft landing. We were looking at our historic debt levels.

Let's go back a time to like 2000. Total debt levels. I'm talking about individuals, corporations, governments, state, local, and federal. All of our debts in the United States amounted to about $16 trillion, which was equal to about 154% of GDP at that time. Fast-forward to today, our total debt levels have quadrupled almost to $59 trillion, equal to 224% of GDP. The reality of our economy is that we built up the biggest debt levels throughout human history, and we cannot sustain these debt levels with interest rates now at 15-year highs. Our economy is now addicted. We're completely dependent upon 0% interest rates. Anything much higher than that is going to completely unravel everything. That's what we're seeing right now, which brings me to the last point about recession. Because we knew that the economy couldn't sustain interest rates at this level, that's what we call for a financial crisis.

What do we see happen in span of two months this year? We had three of the four biggest bank failures in U.S. history happened in the span of two months. That's a financial crisis. This regional bank crisis, as they're calling it, now, because of that, now the experts have changed their tune. Now they're saying, "Well, at worst, we might have a mild recession." No, no, no, no, no. You have to look around what's going on in the economy. Everything is showing. All the signs are saying we're not going to have a mild recession. They're going to say or they're saying, "We're going to have a severe recession." They're also saying that we're probably already in recession. Now I just want to go over a few of them. The first one is the yield curve inversion. This is considered the holy grail of recession indicators. The three-month treasury rate is trading higher than the 10-year by the largest margin since right before the 1981 recession. Keep in mind, at that time, the 1981 recession was the worst recession since the Great Depression.

Now, what I think is even better indicator than even the yield curve inversion are government revenues. You take records back to 1950, every time we've seen a meaningful drop in government revenues year over year, the economy was either already in recession or shortly about to go into recession. This fiscal year, this first eight months of the fiscal year, government revenues are down 11%. Now, put that into perspective. All of 2008, which is the first full year of the great recession, government revenues only dropped by 3%. We're far outpacing that. Let's look at retail sales. We all know, America's all about consumption. Consumption makes up nearly 70% of GDP. Real retail sales adjusted for prices are down seven months in a row year over year. The last time we saw a streak like that, 2009. Now, not a good sign. The last thing I want to touch on with regards to recession signs is just the labor market.

Because all the experts are now saying, "Well, we can't be in a recession. We can't be on our way to a bad recession if the unemployment numbers are so low. Well, look at how many jobs we create each month." On the surface, I agree with them, but if you take one look below the surface, you'll see that the labor market is not as strong as we pretended to be. Look at real wages. We've heard so much talk, especially the previous two years, about reopening economy and the wages are soaring because employers just can't hire enough people, blah, blah, blah. Real wages during that entire time weren't going up. They were going down 26 months in the row. Now through May, real wages year over year, have fallen. Rid of me this bad man. If the labor market is so strong, why aren't real wages going up?

Now combine that with the fact that we have seen the most job cut announcements year to date since 2009. As far as all these jobs are still being created, apparently each month, a lot of these jobs are going to the same people who already have jobs. These are second and third jobs that people are picking up. Why? Because inflation is so bad. They're trying to keep their head above water. I don't buy into how strong the labor market is. It is really a weak market macerating as a strong one. I think as time goes on, we'll start to see that in the headline numbers. I just want to conclude by saying, add all this up. Inflation, interest rates, now recession. What does that spell? Stagflation. That's the reality of the environment that we are in. Unfortunately, we've seen this bad movie before. This specifically what the recession goes. We know that the Federal Reserve is not going to keep maintain this fight against inflation while the entire economy is imploding. That's not going to happen.

They're going to stop fighting inflation to do what? Save the economy with what? More inflation. They're going to go back to quantitative easing. They're going to go back to blowing up the balance sheet, et cetera, et cetera, et cetera. Now, how this is going to impact the industrial real estate market is going to seemingly change overnight, I believe, because right now, it's all about expectations, inflation expectations. Right now, they're low. Everybody's worried about inflation today, but basically nobody in the financial community is really worried about inflation tomorrow and the future, because they think the issues has been resolved. We've seen declines in the CPI. They think the worst is behind us. No, no. The worst is right in front of us. When everybody wakes up to the realization that we're in stagflation, that we're in a very severe recession, that the Federal Reserve is going back to QE, blowing up the balance sheet, effectively doing what? Pouring gasoline on an inflationary fire, that's when people are going to start to scramble. That's when investors are going to start to scramble.

All their expectations are going to change, and they're not going to want to invest in properties that have a 6% cap rate. They're not going to invest in properties that only have a 1-2% rent escalations. That's why I've been calling for owner users, people of businesses, the owner of properties, and they're considering doing a sale-leaseback where they could generate capital by selling their building but renting it back from investors, I've been encouraging them to act now, to do that today. Don't wait until everybody realizes the environment that we're in. Especially if we're having a credit crunch and then demand is really cut off, don't wait until property evaluations start crashing. Act today. Take advantage of the market conditions today. Sell your property today. Do a long-term sale-leaseback where you don't have to pay two or 3% rent escalations. You're going to be happy that you did that.

Boris Duric:

That's some great insight, Devin. Now that we know that the triple threat is really a reality and it's here to stay, where do you think the investment opportunities are over the next 10 years?

Devin Roundtree:

Yeah. Big-box warehouses, they caught all the headlines. They got all the attention over the last decade or two. But this decade going forward, I think it's going to be about specialized industrial properties. I'm talking about properties that are used in the production and distribution of goods that are globally traded. Now, the reason why I say you need to invest in specialized properties, because these properties usually have costly tenant improvements. You have to understand the environment that we're going into is one in which vacancy rates are going up, so is inflation. If you want to protect yourself from the cost of living, you have to be more aggressive in raising rents, but you can't do that if all you have to offer is just four walls and a ceiling. You have to make it so that your property is one that has machinery, it has overhead cranes, whatever.

They have significant costly tenant improvements that will prevent your tenant from easily packing up shop, moving next door to the next empty warehouse. Now, as far as having a property that is catering to global trade, the reason why I say that is because in a stagflation environment, like we had during the 1970s, the dollar's not going to just be losing value here at home. The dollar's going to be losing value overseas against other currencies. Our foreign trading partners, which we've been running these massive trillion dollar trade deficits with, they're going to stop hoarding our currency and they're going to start selling it. They're going to buy up products, commodities that we make here at home. They're not going to be buying up our treasury debt anymore. They're going to trade in their treasury debt for oil. That's why you want to be involved with globally traded goods that have a global market.

Boris Duric:

As we close our conversation, what's the most important takeaway you think investors and owners should be thinking about right now?

Devin Roundtree:

Yes. I mean, whether you're an owner, user, whether you're an investor, you have to completely change your mind frame. The United States of America, we used to be, I like to use analogy, we used to be like this prize fighter, this world-class athlete, and we did everything the right way. We ate well, we worked out, we slept well. Economic terms, we saved, we produced, we manufactured. Now, that's not the basis of our economy. The basis of our economy is that we're on steroids. That's all we got. All we got are low interest rates. All we got are inflation, borrowing, buying from the rest of the world. When you take away our economic steroids, you take away those 0% interest rates. You're quickly seeing how weak our economy really is. That is the reality of the situation. That's why I say inflation is not going anywhere.

It is here to stay and stay for much longer than we are going to hope or anticipate. You have to start thinking, how can I protect myself from inflation? One. And then because I have knowledge, because you understand the situation more than your competitors do, how do I benefit? How do I gain from that? For only users, you want to sell your property now. Even if you don't need the money, consider it dry powder. You hear so many successful stories about companies growing the most when? During bad times, not during good times, during bad times. Well, if your competitors are going out of business and they're having a fire sale in all their supplies, all their equipment stuff, you can't take advantage of that if you don't have dry powder, especially if [inaudible 00:17:52] standards much tighter. We're in a credit crunch. If you sell your property and do a long-term sale-leaseback, even if you don't need the money, at least you're prepared to either protect your business, if needed, or to grow your business if you have the opportunity.

For investors, the one thing you got to keep in mind is that we're talking about a small percentage of the industrial real estate pie as far as those type of properties that act as inflation hedges, those specialized small industrial properties. I'll give you example. When we just look at manufacturing, food processing, and R&D properties between 10 to 50,000 square feet, as we define small industrial, those properties make up only 6% of the entire industrial real estate inventory. You cannot wait until these properties become in headlines. You can't wait before they become hip and cool, then you want to jump on a bandwagon. They're going to be gone. The only way you get your hands on them, you're going to have to pay exponentially more than what they're training for today. I'll give you a quick example. We sold a property TAG industrial. We sold a property earlier this year up in Kansas City. It's a 24,000 square foot research and development property.

The tenants are ExxonMobil and ALS Laboratory Group. It's in the oil field district up there, and it sold at a 8.4% cap rate, relatively high compared to the nation white norm. Now, in the future, I think that property, relative to other properties in the industrial market, is going to trade a much lower cap rate because the value of that property is going to be significantly higher. It's about tenant improvements. It's about what industry the tenants are involved in. Look at oil in the 1970s. Oil went from three bucks a barrel in 1970 to $40 in 1980. That's the increase of 1000 towards 30%. We could realistically see a similar move in oil prices today. You can't tell me properties that depend, that oil really depends on those type of properties as far as the production and distribution, they're going to go along for the ride. If you really want to benefit, if you really want to knock it out the ballpark, you got to make those moves today. You cannot wait.

Boris Duric:

Devin, thank you so much for sharing your perspective with our listeners.

Devin Roundtree:

No, I appreciate the opportunity. I really do. If people are interested in learning more, they want to get a hold of the next Industrial Watch magazine that's coming out in July, go ahead and email us at TAG Industrial. Our email address is You'll be able to get your hands at another copy.

Boris Duric:

Looking forward to it. Thank you.

Devin Roundtree:

Thank you.

Transcribed by

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Boris Duric

Boris Duric is an Audit Manager in the Real Estate Services and Construction Services Groups. He provides accounting and auditing services for a variety of real estate and construction clients.

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