- Trade tensions are causing business sentiment and capital spending to decline.
- The trade conflict is entering a new phase that will more directly impact consumers.
- There is evidence that imports were pulled forward ahead of tariffs, contributing incrementally to already-strong industrial market performance due to the boost in demand.
- Inland Empire and New Jersey markets are particularly impacted by recent trade issues.
- Future impacts will be determined by progress in U.S.-China trade negotiations.
Global trade is a major driver of industrial space demand, but the flow of goods impacts some markets more than others. For example, in the U.S., close to 40% of all imports from China flow through the ports of Los Angeles and Long Beach; not surprisingly, the Inland Empire market is seeing the impact of the conflict. Up to this point, importers pulling demand forward to avoid tariffs added more impetus to already-strong industrial demand. Looking ahead, port volumes are likely to see some choppiness while supply chains and locations of final production evolve as the trade conflict continues and negotiations unfold.
Broader Economic Effects
The impacts of current trade tensions have been uneven up to this point, with CEOs becoming more pessimistic about the future as the trade war ramped up.1 At the same time, consumer confidence has remained near cyclical highs,2 as many consumer products made in China—including clothing, toys and electronics—had been excluded from the tariffs. Meanwhile, businesses began to feel the impact of higher input costs as previous rounds of tariffs were applied.
The impacts of trade tensions will broaden in the months ahead, following a planned 10% tariff imposed on some additional Chinese imports beginning on September 1, although the tariff imposition on a broader range of consumer goods has been delayed until December 15.
Figure 1: Business Confidence vs. Consumer Confidence
Source: Federal Reserve Bank of St. Louis, Business Roundtable, University of Michigan and CBRE Research, August 2019.
Note: Circle highlights a precipitous drop in business sentiment.
What will the economic impact be if there is not a resolution to Sino-U.S. trade conflict? An assessment is not easy since moves to boost tariffs to this level in the U.S. have not happened since the 1930s, when the infamous Smoot-Hawley Tariff Act was enacted. Some Wall Street estimates put the impact at around half of a percentage point off of GDP growth. In terms of direct costs to the consumer, if all tariffs go to 25% on Chinese goods, some estimates put the cost at roughly $1,000 per family—enough to offset much of (if not all) the positive impact of U.S. tax reform for a typical household.
In the business sector, trade tensions are already negatively impacting business investment, which declined by 5.5% in the second quarter of 2019. The key question is, will consumer sentiment also sour as higher prices begin to eat away at disposable income? As evidenced by the initial estimate for U.S. GDP in Q2 2019, business investment was down but consumers remained strong, fueling growth which came in at 2.1%—close to its longer-term trend.
Tariffs and Industrial Real Estate
Reports from large port markets indicate that demand for China-produced goods was pulled forward to avoid tariffs on products before they went into effect. These import surges and corresponding moves in absorption are observable in the data. One wave came in late 2017, and another at the end of 2018, both before various tranches of tariffs were put into effect. Los Angeles/Long Beach, New York/New Jersey, Savannah and Seattle account for three-quarters of Asian import volumes.3 Our analysis focuses on these markets for that reason.
The Inland Empire and New Jersey were the two port-associated markets most impacted. This is not surprising, as the two Southern California ports (Los Angeles and Long Beach) account for close to 40% of all Chinese imports into the U.S. Chinese imports also account for around 30% of volumes at the Port of New York and New Jersey. In short, the data show higher volumes ahead of tariff levies.
On a rolling four-quarter basis, net absorption in New Jersey rose by 115% (through Q2 2019) compared to the same period one year prior. The Inland Empire also experienced heightened space demand (3%) during the same period. Additionally, the Inland Empire is seeing more sublease activity resulting from the uptick in imports at the end of 2018. This is not surprising considering imports spiked 11% year-over-year in Q4 2018 at the Port of New York and New Jersey. As for the ports of Los Angeles and Long Beach, import growth was up 9% during the same period.
Although these bumps in demand were reflected in elevated absorption levels in the markets we analyzed, rents have not yet been meaningfully impacted; still rent growth has been very healthy in both markets amid exceptionally low vacancy. In short, the overall impact has been some short-term volatility in markets most exposed to China, but—perhaps counterintuitively—that impact has been marginally positive up to this point.
|Figure 2: The Impact of Imports on Demand, New Jersey
||Figure 3: The Impact of Imports on Demand, Inland Empire|
Source: CBRE Research, various port authorities, June 2019.
Note: Rolling 4-quarter net absorption vs. loaded imports. *2019 is through Q2 2019.
Real Estate Outlook
Looking ahead, we see the potential for further, less positive impacts across the top-tier port markets. It should be noted that currently, these markets boast extremely strong fundamentals, and trade with China—while important—is not the only demand driver. Both New Jersey and the Inland Empire maintain vacancy rates in the low single digits and demand continues to outpace new supply; this is resulting in very strong rent growth.
As trade tensions continue, two factors need to be watched. First, the broader economic impact: If consumers follow business in reining in spending, a broader economic slowdown would, of course, negatively affect industrial market dynamics. A precipitous or prolonged fall in the stock market, perhaps in reaction to a trade-related event, would produce this effect. The second consideration is that producers and their supply chains will adjust, as illustrated by Figure 4, highlighting import growth from Vietnam vs. China. Such adjustments will eventually replace some of the demand previously created by Chinese imports, but there may be some degree of volatility as that occurs. There may also be some reshoring of manufacturing, but the extent to which this occurs remains an open question and may not significantly alter market dynamics.
Figure 4: U.S. Import Growth: China vs. Vietnam
Source: U.S. Census Bureau, July 2019.
Note: Circle represents a spike in Vietnamese import and leveling off of Chinese import growth.
Future impacts will be determined by how much progress is made in resolving trade differences between the U.S. and China. As such, uncertainty will continue to be a feature of the market landscape. Furthermore, the potential for adverse impacts on property markets is real and should be monitored; but up to this point, the trade war has been a marginally positive driver for industrial real estate. Additionally, in terms of resilience, industrial real estate will continue to enjoy support from structural shifts in demand, most notably from the growth of e-commerce.
In terms of industrial markets, if there is meaningful resolution on the issues currently being negotiated, future impacts will be somewhat muted. On the other hand, if trade negotiations drag on—which it appears they likely will—impacts will become more pronounced and observable in market dynamics. Still, other factors should be assessed as well.
Even amid a slowing global economy and trade tensions, the U.S. economy grew at a respectable 2.1% rate in the second quarter of 2019. Furthermore, the labor market remains very strong. This strength is showing up in consumer sentiment, which remains very high. All of this is important to note because consumer spending accounts for approximately two-thirds of U.S. economic activity.
Additionally, central banks began cutting interest rates, which will further support economic growth. This loosening of monetary policy underpins CBRE’s expectations that, although growth is slowing, the U.S. will continue to maintain growth during the near term. With consumers propelling the economy ahead, on a broad level, real estate fundamentals will also be supported.
Economic resilience, translating to property market resilience and a lower cost of capital, provides a reasonably positive mix for capital deployment in real estate. Although various risks will continue to weigh on growth, CBRE’s expectation is that the outlook is supportive of property market fundamentals, which combined with lower interest rates, will present opportunities for investors during the near-term.
1 Business Roundtable and CEO Economic Outlook, Q2 2019. See Figure 1.
2 University of Michigan Consumer Sentiment. See Figure 1.
3 IHS Markit, 2018.