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How Will the Industrial Sector Fare in 2020?

[Updated: Nov 16, 2020] Feb 14, 2020 by Matthew DiLallo
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Demand for warehouse and distribution space in the U.S. weakened during the fourth quarter, according to data from Moody's (NYSE: MCO) real estate analytics arm REIS. That's primarily due to the continued impact of the trade war between the U.S. and China, which has nudged up the sector's vacancy rate over the past year while also weighing on rent growth.

However, with phase one of the trade deal now signed, and China recently cutting tariffs on several U.S. goods, demand for industrial space could pick up this year.

Digging into the fourth-quarter data

REIS noted that end users only absorbed 14 million square feet (SF) of warehouse and distribution space during the fourth quarter. While that's well above the nine-year low of 4.3 million SF during the second quarter, it was half of the quarterly averages last year and a third of 2017's average.

What makes that low absorption rate concerning is that the industry didn't complete as much new space during the quarter. Overall, developers finished 19.2 million SF of new warehouse and distribution space in the period, which was well below 2018's quarterly average of 35.8 million SF of new space added to the market each quarter.

With net absorption running below the amount of new space added, the vacancy rate remained high at 9.9%. While that was unchanged from the third quarter, it's above 2018's fourth-quarter level of 9.4%. That elevated vacancy rate weighed on rent growth, as both asking and effective rents (the rental rate after accounting for leasing commissions and tenant improvements) only increased by 0.4% for both, compared to the third quarter. That's a much slower rate than in the prior-year period when both increased by 0.7%. For the year, asking and effective rents grew 2.2%, which was a much slower pace than 2018's 2.8% asking and 2.9% effective rent increases.

What's ahead for the industrial real estate sector in 2020?

Manufacturing and trade activity continued to slow during the fourth quarter. REIS noted that the Purchasing Managers Index (PMI) fell to 47.2 in December. That was a concerning number for several reasons, including that any reading below 50 represents a contraction in manufacturing activity.

Further, December's reading was the lowest level since June of 2009 and below market expectations of 49. It also marked the fifth straight month of declining manufacturing activity due to the impact of the trade war between the U.S. and China.

Meanwhile, trade data also weakened at the end of 2019. The total amount of goods exported and imported fell $27 billion, or 2.6%, during the year's final quarter compared to the third quarter and $47.2 billion, or 4.6%, versus the year-ago period.

However, the U.S. and China signing the first phase of a trade deal in early January should have a positive impact on the industrial sector. REIS believes that leasing activity should accelerate in 2020 now that the trade war threats have subsided.

That forecast bodes well for commercial real estate investors who own industrial space as well as those who hold shares of real estate investment trusts (REITs) focused on the sector. Industrial REITs enjoyed a strong performance last year despite the weaker market conditions as investors looked forward to the end of the trade war and the positive impact that continued e-commerce growth is having on the sector.

Anticipating a bounce back in 2020

While last year was a weaker one for industrial real estate, sector fundamentals appear as if they'll improve this year as trade war headwinds subside. It could help accelerate rent growth while driving down vacancy levels, which would help bolster the returns investors earn from these properties.

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Matthew DiLallo owns shares of Moody's. The Motley Fool owns shares of and recommends Moody's. The Motley Fool has a disclosure policy.