AMB: Production, Trade, Inventories Must Rebound

SAN FRANCISCO-Production, trade and inventories have fallen so low that production and trade will have to increase in order to maintain inventories for even baseline demand, according to a research report released Monday morning by AMB Property Corp. The locally based distribution REIT is predicting twice as much positive industrial absorption next year as there has been negative absorption through the first three quarters of this year.

For its research, AMB defined production as the manufacturing component of US industrial production, trade as the sum of imports and exports in real (constant) US dollars, and inventories as private inventories in real (constant) US dollars, as defined by the Bureau of Economic Analysis. What is found was a significant correlation between production, trade and inventory growth with demand for industrial real estate (net absorption as a percent of stock), with the correlation ranging between 85% and 89%. “The causation analysis suggests that trade and production are the primary drivers of net absorption,” states the report. “The relationship between inventories and net absorption is also highly correlated, but the existence of causation is difficult to imply; possibly because utilization levels and inventory flows vary throughout both sides of an economic cycle.” The company also used linear regression models to equate historical changes in production, trade and inventory levels with changes in industrial real estate demand. What it found is that each of the three factors individually explain between 73% and 79% of the historical variation in net absorption (1990-2008), and as such, “each should be considered a solid indicator of industrial real estate demand.” Despite the strong linear relationship with each other and with demand for industrial real estate, AMB says much has changed in the past year and a half. While US consumption and net absorption have decreased by about 2% from their peaks, production and trade have declined by more than 16%, it says. Real inventories are down a more modest 6.9%; however, nominal or current inventories have fallen by 13.7% from their peak in 2Q08. “It is apparent that trade, production and inventories have fallen much farther than would be warranted by consumption (demand),” states the report. “However, production and trade are beginning to recover [and] we believe these variables will continue to rebound, as there is no evidence that the structural relationship between these variables has changed. “They are the foundation of the global supply chain, and the relationship between production, trade and inventories is a long-standing one and has evolved over many decades. Goods will continue to be produced and will need to be stored and distributed. Trade continues to serve as a means of raising productivity and lowering overall costs.” While one-third better than the second quarter, third quarter net absorption was negative 50 million square feet, bringing the year-to-date total to a negative 225 million square feet, the biggest annual decline on record. AMB expects the fourth quarter to show greater improvement though absorption may still be negative. The consensus estimate for industrial production in 2010 is currently 3.5%, and independent forecasts call for trade growth of 5.4% to 7.7%. Consensus trade forecasts imply 2010 US net absorption of more than 100 million square feet and 500 million square feet globally following negative absorption of 225 million square feet through the first three quarters of 2009. Last week, with regard to its own performance, the company said it expects occupancy and rents to bottom out in the next two quarters and begin to show improvement in the second half of 2010. Company executives cited industrial’s lagging relationship with the US economy, which is expected to show growth in the first half of 2010. “Leasing and capital expenditures have been on hold as businesses focused on cutting costs and gaining efficiencies [but] decision making has resumed,” AMB chief executive Hamid R. Moghadam told analysts Wednesday afternoon. “Property showings and deals in negotiation are starting to increase and our strongest customers are beginning to execute previously shelved plans. The first wave of this [resumption of activity] will fill empty leased space, followed by demand for new space. It will take at least three- to six months for the increased demand to show up as occupancies gains and revenue.” Also last week, AMB’s main competitor ProLogis said it, too, sees early signs of stabilization in industrial property market fundamentals. The decline in occupancy appears to be coming to an end and its core clientele is starting to emerge from recession-induced hibernation, says ProLogis chief executive Walter Rakowich. “While there continues to be pressure on market rental rates, overall market occupancies seem to be stabilizing, with an increase in customer activity,” he said. “Some supply chain reconfiguration plans that were postponed are coming off the shelf, and there is growing customer interest in new build-to-suit development in global markets where there is a lack of appropriate supply.”