How Supply and Demand Dynamics Effect Industrial Real Estate


Justin sits down with Peter Linneman of Linneman Associates to discuss how supply and demand dynamic effect industrial real estate. Peter explains how demand continues to outrun supply and how the upward trend of online sales plays a role. Peter offers a quarterly Linneman Letter that covers the current economy, real estate topics and provides insight based on data.


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  • Quarterly Linneman Letter – 1:15
  • Industrial demand – 7:00
  • Supply and demand effecting warehouse space – 8:15
  • Demand is exceeding supply in industrial – 14:40
  • Demand factor improving by automation – 19:45
  • The shift of real estate professionalism – 21:00
  • The economy normalizing will take time – 26:00
  • Inflation signaling the need of supply – 30:00
  • 2022 and 2023 are the years of normalization – 32:00


Episode Resources

Connect with Peter Linneman

Connect with Justin Smith


Justin Smith: I’d like to welcome Peter Linneman of Linneman Associates to the Industrial Insights Podcast. I actually found my book. So second edition when I joined the Peter Linneman fan club.

Peter Linneman: Well, I think we’re on our eighth edition at this point. We’ve got hopefully a fair number of fans out there and you’re very kind to have me, Justin.

Justin Smith: I found your book just to learning more about the industry, but as I’ve become now 17, 18 years in the business that I’ve gotten to see all sorts of contributions that you’ve made. So it’s exciting to finally meet you and talk with you a little bit. One of the last podcasts that I’d seen was this Walker webcast that you were a part of. I’m not a subscriber to the Linneman letter. I need to be. I think that’s what I learned from that podcast.

Peter Linneman: Well, that’s another part of the family. There’s a lot of folks that join us in that and follow on kind of a continuing story. I think we’re in our 21st year. That’s also been a fun exercise.

Justin Smith: So, can you tell me a little bit and our audience a little bit about what it is, how often it comes out and kind of some of the topics that you cover?

Peter Linneman: It’s a quarterly publication. I write long letters. It has different parts. It has a regular tracking of big parts of the economy with my insights, but also lots of data and charts that people find useful for their own clients and their own team. It has special topics, like what determines cap rates, what are the advantages and disadvantages of long hold real estate investing, et cetera. It has regular tracking of real estate and broader capital markets and where I believe they’re going. And then it also has a series of focus on about 60 major metropolitan areas where they’re at in the major food groups and where they’re heading in the major food groups, as well as national overview. And then there’s usually a take on what I would call a pet topic and a pet topic might be my take on inequality and the challenges of majoring and really understanding something as nuanced to send a quality. Or one I’m working on for the next issue. Which will be about the 1st of April. Everybody says this, whatever this is in quotes is the biggest problem we face. And so I muse for a couple of pages on what I think are the biggest problems the world faces and why. And sort of challenged the reader to pause a moment in their day. And just say, okay, now let me just think for real, what are the big problems and how might I prioritize? So it’s a combination of information, information analysis, micro, macro, real estate, broad economy, and capital markets. But the big thing is not so much that I’m right. I mean, if I was right the whole world was subscribed and everybody be doing the same thing and therefore everybody be wrong because everybody’s doing the same thing. But it is as much as anything away to challenge you, to challenge your own thinking. When you think about risk and opportunities in your clients and your firm and your strategy and so forth, that’s what we try to do.

Justin Smith: Yeah, you’ve got to put a stake in the ground to have an opinion in the first place. And you have to have looked and thought through things, and then as the reader see what was Peter’s? What is mine and where’s their space?

Peter Linneman: That’s the real point you got it. And I’d like to think I’m right. My wife of almost 49 years would disagree with that with some regularity, but I think its bigger value is I try to carefully take data. I try to carefully look at things as carefully as I can and articulate why I believe what I believe. And in so doing, allow you as the reader to challenge your own thinking. Like I hadn’t thought of it that way. Or I think he’s crazy because right. Almost like you might do in a conversation, right. Or, you know, if I was sitting down with a client or working overtime with a client.

Justin Smith: I got that out of your letter and your interview and I’m sure a lot of people do when you think of the rising interest rates and the flow of money and cap rates. It seems like one of those moments if you don’t take that moment to pause you, miss it, or you don’t really, like you think there may be tied more than they really are. Or the relationship is different than what meets the eye.

Peter Linneman: Oh, we might talk about inflation, and I try to, I could be wrong. But I try to clearly stay well, and you’ve read my book and you know how you can hear my voice as you’re reading. I think you can hear me as you’re reading it. If you’ve ever heard me, it is my style and Linneman letter is written in the same way. You can hear my voice, so to speak. And therefore, I think in a way, you know, how process it. As I say, I’d like to believe I’m always right. Occasionally I’m right. Occasionally I’m real right. For example, one of the topics I know you’re focused more on industrial, but we’ll come back to that. But one of the topics was if you recall, in the first half of the pandemic, everybody was saying the internet retail is going to wipeout all brick. And there was a huge jump in online sales. And I kept looking at the data going, first of all, if you can’t get your sales up, when your competitor is closed, you got a problem. And by the way, my comment over the first half of the pandemic was as soon as stores are allowed to function. And as soon as people feel comfortable, go back to stores, stores would hit record sales, which they did. And the second is it’s not like online disappears, but it goes back to trend. Well, that’s exactly what’s happened. It’s gone back the trend. Now it’s an increasing trend. So essentially sales are flat lining adjusted for inflation. They’re flat lining and the trend is coming up to them. So that’s another one where I don’t think most people had quite thought about it that way. Again, industrials another good example. I couldn’t figure out, I’m going to go back to like 2016, 2017. You saw strong industrial demand, right? And no matter how much supply was being created, there was more demand. And then you’d get more supply brought on and there was still more demand. And then you would get more supply brought on an 18 and there was still even more demand. And no matter how supply picked up demand was out, running it in 16, even more so 17, even more so 18, 19. And as you know, that’s continuing and I’m going, how can that be? How can you keep increasing supply and demand ever runs faster? There’s got to be something going on. Well, I was very tuned in to the online retail. I’m quite involved. I’m on the board of a major shopping center company for many years. So I’m quite attuned to the rise of online sales. And I kept looking at the rise in online sales, retail sales. Going, it’s got to be related to this demand picking up ever faster. Because if all it is by the way, if it’s H&M selling at a store versus Zara’s, it doesn’t have any net impact on warehouse space. It’s only together they sell more. And so I kept going in what’s going on? Well, as we looked at it, as we looked at some of the layouts, as we look more closely at some of the engineering factors, a few odds and ends little snippet studies kind of came to the belief that if you go to the store and buy your vest and then I ordered the same exact vest online the amount of warehouse space needed for my vest is three times roughly what it was for your vest. And you go now let’s get that straight. And of course it’s because wider aisles are needed. Assembly space is needed. Handling is needed small boxes rather than big pallets, et cetera, et cetera. But it took us a while to figure that out. Well, now the trend in demand made sense because normally you would think, gee, if retail sales in total are up in real terms, 2%. You would normally think in historically would find industrial space, you need warehouse space at about 2% more to deal with that, right? Just crudely. You have 2% more shirts, 2% more warehouse, but because of this upward trend in online, it’s skewed. And when I did some back of the envelope and I don’t want to be overstating its precision where you include true industrial activity, true import export activity, brick retail, and online retail, and everything is growing at about the rate of the economy except online retail, which is growing faster than the economy, but it’s a three to one demand factor. When I did that, you come out saying you get an economy that grows real terms two and a half percent in a year. You need about 4% more warehouse space either. That’s a huge, and that’s not how our minds normally work, right? Your mind normally works kind of proportional, but an ongoing 4% for two and a half percent. Oh, yeah. So, I mean, that’s a good example. Now am I right? I don’t know, I think I’m right. I lay out why I’m right. It gives somebody a frame of mind for it.

Which when everybody thinks of where we are at in the cycle and all real estate cycles and economic cycles, business cycles, and thinking through future investments. And so many people thinking e-commerce either extended the cycle, made the cycle maybe not relevant, but like as if we missed a trough in the cycle. It’s an interesting to think of like that that’s related to this of just like the fundamental understanding and trying to figure out things are changing. And how, how does that affect your mental model you may have of when the buy-in or how long to hold?

Peter Linneman: Absolutely. And is it temporary? To what extent is a phenomenon temporary? To what extent is it cyclical? To what extent is it secular? And try to unpack those, one of the odd things about me as I’m not political at all. This is kind of tongue in cheek, but it’s not so far from true. I think all those people in Washington and by the way, in the state capitols, and by the way in the city halls, they’re all basically the same. Scoundrels and so forth. I may not be right about that. I have a lot of data that would suggest it, but I may not be right. And I’ve always felt that way. I’ve always, really felt that way. So I’ve never approached any of these problems of my team, my party. And once you do that, it’s very hard to be objective. It is just harder to be objective. If you think all the parties are kind of like ugh. If it’s free, at least analytically it’s free. So that’s what I do a bit.

Justin Smith: Yeah, let’s dig in a little bit. As it relates to industrial, and we don’t have to totally stick to that all the time. I’m in Southern California but people that I do work with, that I do work for and people that listen are all across the country. So, I think it’s equally as relevant to a lot of the different markets. We’re all seeing values off the charts we’re seeing rental rate increases escalate beyond imagination. You’re seeing annual increases in the lease contracts, like as no longer the fill in the blank 3%. So you’re having people go up almost 5% annual increases and even contemplating larger. And it’s just changing how people are making decisions. And so, I assume for you, you would think a top down broader economy as it relates to industrial before getting into the weeds of any market.

Peter Linneman: And of course there’s three layers, right. There’s this broader what’s going on. Second is how is that playing out in Phoenix, San Diego, or wherever. And the third is what about that property? Which has specific leases or specific traffic accident, access, or specific design features. So it’s those three. In my life, I may spend at the third level, but most of its spent at the first two in what I write and talk about. So let’s unpack, let’s unpack why I think you accurately described it. And I think there’s several things going on. One is demand has been increasing at about 4% a year. And supply has been increasing at originally 2%, then two and a half. I’m doing kind of national numbers, right but 2% and then two and a half percent and then two and three quarters, and then maybe nudging 3% a year of the stock. Well, if supply demand is growing at 4% because of what we talked about, that three to one. You just keep getting farther behind, even though the supply level picks up, when will that upward pressure on rent and the tightness of occupancy end? By the way, I’m not trying to make the four, like it’s an etched in stone number. I’m just trying to put it out there, by the way. If supply grows to three and a half percent of. And demand’s growing at 4% a year. What’s going to happen to rents are going to go up, even though supply kept expanding. And by the way, until demand is 4% growth and supply hits 4% growth, and it’s got a long way to go to that. Rent’s going to still get pushed up. Now, once it gets to where supply is 4% a year in demand is growing at 4%. You don’t kind of stabilize with inflation right on top of it. Now here’s the, there’s two challenges to that scenario. I think it’s the real scenario and I think it’s what’s going on. And of course, then NOI is built up and some people think they’re going up for magic. They’re not going up magically. They’re going up for a supply demand reasons. Here’s the two weaknesses in that story. One is that a lot of that demand and it’s real, there are real boxes basically being stored there. It’s real. A lot of it is with companies who are not making money on their sales. And so one of the things we’ve looked at and all you have to do is look at Amazon most recent financials. And in Amazon’s most recent financials they lose, I’m doing from memory, they lose something like 4 billion, a quarter on everything except the cloud. So the cloud makes money and everything else loses money. Everything else, Amazon does lose money and the cloud makes enough money that the Amazon net net is making money. The numbers are in their financials. Now you think about that. And that’s true, if you talk to grocers, it’s true. By the way, nobody says this very loud, but if you talk to most online sales entities, whether they’re dedicated entities or it’s part of an omni-channel is that they don’t make money on their online sales, especially on items where it’s small margins and high handling costs and higher returns. So if you sell me a book online and it’s a virtual book. Yeah, you make money on that. If you start shipping me that book, there’s handling charges and shipping charges and the margin wasn’t that big, you don’t make money. That’s why Amazon stopped really selling a lot of books physical and went to doing it virtual. So one of the problems is yes, you’ve got online sales growing. It’s real growth. It’s real demand, but it’s money losing demand. And the question arises if tomorrow all those retailers had to make money incrementally on their online sales rather than having the capital markets fund their losses. By the way, the consumer wants to buy. That’s not the problem. The problem is who the heck wants to sell. If all that I do is lose more money. And as long as the capital markets let me fund it, I’ll do it. And the capital market. So that’s one, could change rapidly. And the second is I was talking about the 4% but let’s suppose that doesn’t happen. That the 4% that I was talking about and now you’ve got 4% of your demand growth, 3% spot, 4% demand growth, three and a half percent, 4% demand growth, four and a quarter percent supply. And it shoots by it at the same time. Remember every day somebody wakes up at Amazon and tries to get that three to one factor down to two to one by robots, by more efficient layout, by whatever, by design.

Peter Linneman: So you could have a situation over the next five or six years where really robust demand and I’ll use Amazon. And then Amazon figures out how to get it from being three to one to two to one. And suddenly the demand factors out a 4%, a year growth. It’s a 2.9% growth. And now supply finally started catching up to get the 4% and you slide by it. So those are the two flies, but meanwhile, you have real fundamentals. You have real excess demand. You have continued excess demand and institutional capital went from hating it. By the way, when you started what’d, you say 18 years ago, you didn’t, other than the million square foot kind of stuff, you didn’t see much institutional capital and warehouses. Now you have Prologis, and you have, you know, all these Rexford and you have all these reaches and you have big institutional portfolios. You have Blackstone’s portfolio, you have DLC. So you have a very different landscape from a capital market point of view. It went from an institutional money doesn’t want to be there to institutional money really wants to be there. Well, not surprisingly that reduced cap rates considerably and increased liquidity. And as you know, you’re in the business, if you can virtuously increase liquidity, the cap rate will fall because it’s more liquid, right. So there is a virtuousness there.

Justin Smith: And to see institutional even mean almost any size now, right. Where it did start top down and now there’s a floor, but the floor is so small that, you know, a few million dollar deal there even people stitching together a smaller deal of $5 million deals with institutional funds and it’s pervasive.

Peter Linneman: One of the beautiful things has happened over my career. I started my real estate career in 1985. I started my professional career probably in 1977, but I didn’t stumble into real estate until about 1985. Well, it was not a professional industry. It was hard to get information. It wasn’t transparent. It wasn’t analytic. It wasn’t disciplined. That doesn’t mean everybody wasn’t, but as a general matter right. And what happened was places like Wharton, created programs that train young people and wrote books and wrote articles. And then those people trained people on the job. And by the way, the real estate business today what’s that 37 years later or whatever it is versus 1985. It’s as professional as any other industry. It’s just well-trained. They understand balance sheets. They understand finance, they understand operations, HR, et cetera. Some better than others. Well that meant it got a lot more competitive and a lot more efficient in the sense that you don’t earn excess returns relative to risk so easily. You got to work. And that’s been really rewarding. I was a little part of that by my book, by creating the Wharton program, et cetera. Now, young guys, like you have to live in that world, you know, it’s like, oh my goodness. It’s really hard now but much more professional.

Justin Smith: Yeah, the last of the Cowboys would probably be the era that we’re in, where it’s still alive. But it’s such a small, like the lone wolves that are out there. Yeah. It’s all become a team. It’s become a bigger company.

Peter Linneman: Reporting the guys your age. There’s still a few, even some of the guys, most of the guys, even my age, I’ll be 71 next month that are still in the business. They weren’t the Cowboys, you know, the ones who survived and are my age were pretty disciplined. They were pretty professional. There was a kind of selection bias and therefore, yeah, there are some Cowboys out there. There’s always going to be Cowboys in every industry, but they’re pretty disciplined. They’re more like you highly professional, highly trained, training others and working as teams.

Justin Smith: Yeah, it’s an exciting time to be here, but the excitement is right saying this demand and supply game that you speak of seeing like as a different kind of excitement, for sure.

Peter Linneman: When in doubt, I always encourage people, economics isn’t perfect, just think, supply and demand. It generally works. So if you see something fundamentally happen like your sign that rent’s going up for a sustained basis, not for a week or a month. It’s got to be about supply and demand. It’s got to be. And then what you have to do is think, what is it about supply and demand? I think in the industrial, it’s a tremendous fundamental, demand exceeding supply for several more years.

Justin Smith: Yeah, I’m an economics minor. So, it’s all about the graphs, which way is the graph shifting? So I love that in your letter, you got plenty of them. I think, maybe a last stop is just the 2020 normalization that you’ve gone over in your letter. Maybe if you could touch on that a little bit, that might be a good way of just leaving people with some expectations of what you see out there.

Peter Linneman: Well, if 2020 was a year or oh my god, what just happened. That would be kind of when you’re on your death bed, 40 years from now, 80 years from now, you’re a young guy, 80 years from now when you’re on your death bed and somebody says, what, what do you remember about 2020? And you’ll say, oh, my, it was the year of, oh my God, what just happened? I think if you were to say 2022, it will be by the end of the year things have gotten back to a world I at least kind of recognize not perfectly because if you shut 30 or 40% of am economy down three to six months, some countries longer, some parts of the country longer. There’s going to be distortions that last years. Think of something as trivial. Justin has restaurants. Think of all the restaurants that went out of business or went to delivery only over the previous two years. Well, they’re not all going to just magically appear now that you want to go out and eat again. It’s going to take two to three years to get those restaurants back in order. What happens in the meantime? What happens in the meantime is you want to go out to eat like you did in 2018 and 2019, and you’ve got the money and you’ve got the resources. Oh, there’s 30% less restaurants. What do you think that does to the restaurant prices, to the income for restaurants? I’m taking that as a trivial. You don’t expect all those restaurants that went out of business to be back in a year. That’d be silly or two years or three years. It takes time. That’s true of factories. That’s true of everything.

Peter Linneman: We’re in basically the first year of real normalization. That all those things that got shut down or weren’t allowed to expand, or you panicked, or I panicked, and we shut things down. All of those will normalize by the way. I think Omicron was important. A lot of us who were careful and fully vaccinated, got Omicron, we survived. Thank God we had the vaccination. I think it gave all of us a bit different kind of view of, okay it’s time to get on with life a bit. And be careful, especially if you have extenuating circumstances, be very careful, but you know, okay, let’s go back. I think people going back to work. The older baby boomers who lost their position in 2020, early 2021 they’re not coming back. If you were 68 years old and you thought you were going to work another year or two and you lost your job during the shutdown, you’re not coming back for six days. You took on employment as best you could get, you’re done. Well, what that means is we lost about two years of relatively senior, relatively unskilled. Think of the hostess at the restaurant. Think of the, you know, the senior person among the lesser skilled at hotel. They’re not coming back on the other hand, the person who’s 60 is still going to work until they’re 70. It was a one-time shot. It was a one-time shot. So some of that normalizes because it’s a matter of time. I think what you’ll have is the inflation story. I believe the inflation story is incredibly simple. I think it’s incredibly simple. I’m going to make it so simple that even somebody who went to Harvard could understand it. All right. That’s how simple I’m going to make it.

Justin Smith: We appreciate that.

Peter Linneman: No, here’s the simple since the end of 2019 industrial output is down 1% and real GDP is up 3%. And the reason it’s down industrial output fell from, let’s say a hundred at the end of 2019 down to about 60. And it’s only gotten back to 99, big comeback, but it’s only gotten to 99 for the reason some of them went out of business. They don’t come back to business, you know, and so forth it takes a little while. If we sat here at the end of 2019, and I told you that there was going to be two years later, industrial activity would be 1% less and GDP would be 3% higher. What would you guess what happened to prices? Supply and demand. Demand is more or less up by 3% supply is down by 1%. By the way you say, well, that’s good. What about services? Same thing’s true in services. How do we know it’s true in services? Look at employment. Employment is not back to its previous high it’s come way back. So if you used employment as a crude metric of the service side crude and industrial output. And you go, oh, I get it both of them slashed, the supply side has taken longer to adjust on the demand side. Demand exceeds supply Econ 101. What happens to prices? They spike. Now that’s not monetary. That’s not the fed. It’s a shortfall of capacity. I don’t know how it is raising interest rates get ships unloaded any faster. I don’t know how it gets trucks unloaded any faster. So that’s inflation today. By the way, one more thing on that if I told you at the end of 2019, we were having this conversation. And I said two years from now, real GDP will be up by 3%. Would you be impressed? The answer is no. You said if it grew at two and a half percent a year, for two years with compounding, it should be like 5.4% up over two years, right. So it’s not like demand is crazy. Demand is only up 3.2%, should be up with something like 5%. So it’s not the demand side, right. It’s not that that’s crazy. It’s not that demand is overheated. Its supply has legs. So what do I think happens during this year? Well, what do high prices do? Let’s go back to my restaurant example. You now see prices in restaurants, spiking for your meal. Well, that’s that tell a restauranteur. Open a restaurant. It sends out flares saying open up a restaurant. What happens if I see the price of chips, not potato chips of computer chips going up quite precipitously. It’s sending up a flare saying. We need more supply here bring it on. What happens with warehouses as their prices go up? We’ve already talked about it. We need more warehouses to catch up the demand. So actually today’s inflation is a good thing because what it is doing is sending up signals. We need supply here. We need supply here. We need supply here. Oil now, why is oil price so high? Well, go back to April 2020, it was negative for a week. Negative. You had to pay somebody to take away a lot off your hands. How much capacity do you think was shut down because of that? How many wells were shut down? How much exploration that was planned was stopped? When oil prices were at 60, they were planned oil prices went to $10, $20 for something like a quarter, all that got shut down. So capacity got shut down. We have about the same number of Wells today as we did in the 1980s. Obviously populations larger, the economy’s larger and so forth. So we’re back down to a very low well count. Is it surprising that if we have a lot fewer Wells and a lot higher demand price are up? And the prices are up because the Wells went down because the price was so low. What do you think happens this year or heading into next year? The normalization big flares going off. Okay start fracking again. Start doing it again. And by the way, it also manifests political pressures to allow, right. So it’s not just the economic, it’s also the political, not just here, abroad. And so the normalization is our life, it’s our going back to work, it’s our travel. It’s our going back to the labor force. It’s seeing more capacity come on. I think as a year goes on, as capacity comes on a bit faster than demand grows, you’ll see inflation, moderate. I don’t think it will moderate because of the interest rate increases because it’s not overheated demand. Yes, demand is higher than supply, but it’s back to 3.2% is not over two years, 3.2% real growth. That’s not overheated rope. That’s below normal. So what I see is this being a year and into early next year, normalization. Normalization, just back to something that reflects your normal travel pattern, your normal vacation pattern, your normal go-to work pattern, your normal purchasing patterns, et cetera, et cetera, et cetera.

Justin Smith: Yeah. I love just the simplification. When you go back to the supply and demand and you use that framework and you would apply it to everything, right. It can really bring clarity when you bring that simplicity to it.

Economics probably only has two or three really good insights. And one of them is more or less if demand outstrips supply by a lot for any prolonged period, prices go up. And the second is if there’s a cost to doing something and there’s a cost not to doing something. Another great insight of economics. We’re running out of them. I’m kind of saying we’ve kind of run out of big insights of economics. I mean, I have PhD in economics, and you know, it’s very helpful. But it’s the simple, you know, it’s kind of the 80/20 rule or maybe the 90/10 rule that about 10% of economics is about 90% of the insight. And the other 90% is kind of more or less wasted energy. You didn’t know it was wasted when you were doing it. You don’t know which is the 90 in, which is the ten. I think Keynesian is part of the wasted 90 but be that as it may.

Justin Smith: Well, Peter, I’m sensitive to your time, but we need more Peter in the world. We appreciate you taking the time today and helping us think through what we’re dealing with and applying it to all the people in our world that are focused on this one little niche and trying to make sense of it.

Peter Linneman: Well, I hope it’s been helpful as a great honor and pleasure to be here. And I hope everybody has a great normalizing year and visit Linneman Associates website and you’ll find out both about our business activities as well as my charitable activities there.

Justin Smith: Fantastic, Peter. Thank you!

Peter Linneman: Bye-bye.