The economy appears to be running counter to some economists’ forecasts last year for a downturn in the second half of 2017, and that strength is fueling boom town-like growth for industrial real estate.
This is the conclusion drawn by Prologis from its self-created economic measurement which it calls the Industrial Business Indicator. The IBI is derived from statistical research that is combined with analysis of extensive surveys of industry executives.
In general, anything over 50 on the IBI scale is considered positive. Below that and you can bet on and economic downturn ahead, according to Prologis. The latest IBI activity reading in July came in at 60.1. Since beginning of this year it has stabilized at about 60.
The IBI has proven a reliable leading indicator of not only the demand for logistics real estate, but also the state of the U.S. economy, Prologis notes, including having predicted the 2008-09 recession.
According to the most recent IBI, all the signs point to a continuation of a strong economy and business real estate demand for the foreseeable future.
Prologis says its analysis of the IBI and other key leading indicators suggests that current economic conditions support logistics real estate demand growth of about 200 to 250 million square feet.
The IBI also shows that supply chain efficiency is more important than ever, a change in emphasis that the global industrial real estate firm says it has seen take shape over time.
“Over the past several decades, supply chains have evolved into a crucial competitive advantage for our customers,” Prologis explains.
“When leasing space, they increasingly staff or consult with supply chain experts with an eye toward maximizing the value of leased space,” it adds.
Leasing decisions today are often made in the context of the broader supply chain. This includes making sure to manage such other, larger costs – labor and transportation – to support higher service levels delivered by third-party logistics providers.
The IBI also reveals that space usage has become more efficient over time. The utilization rate has trended steadily upward over the past decade and currently hovers near an all-time peak of about 86%, and logistics real estate users currently have little shadow space.
Net absorption has averaged more than 250 million square feet annually for the past four years. At the same time, real growth in the Gross Domestic Product has averaged 2.2%.
Based on historical trends, this level of economic growth should have generated about 150 to 200 million square feet of logistics demand annually, or more than 20% less than was actually realized, Prologis points out.
The IBI has signaled higher levels of demand, with an average reading above 60 during the last four years, indicating annual demand in the 225-250 million square foot range and showcasing its stronger relationship with realized net absorption than conventional economic metrics.
“Customers are busier and are utilizing nearly all their space,” Prologis reports. “Current availability constraints may be producing higher-than-normal utilization rates as customers try to pack more activity into their existing supply chains, given the lack of additional space alternatives.”
Finding Space to Meet Demand
The company also says the supply pipeline is rising to meet that demand. Space under construction rose to 218 million square feet in the second quarter.
The new supply is aligned with demand, Prologis observes. The exceptions are key logistics markets along the coasts are generally undersupplied.
Market conditions in the San Francisco Bay Area, Los Angeles and New Jersey/New York City, for example, are very tight and new supply lags demand. Rent growth in these coastal markets should approach 10% in 2017.
There are a few pockets of potential oversupply primarily due to low barriers to new development. These include Louisville, KY; Columbus, OH; Central Pennsylvania and South Dallas.
Prologis says the IBI and other economic indicators point to continued growth for logistics real estate tenants, “but a lack of availabilities will drive up costs in the most attractive markets and could potentially constrain expansion activity.”
The company projects 200 million square feet of net absorption and 215 million square feet of completions for this year.
It also says this supply/demand dynamic should hold through 2018, when Prologis expects 215 million square feet of net absorption and 235 million square feet of completions.