At the mid-year point of 2015, the US industrial property market continues to enjoy improving market metrics. Net absorption, vacancy, average asking rental rates and construction activity all point to further business expansion and strong demand, especially for bulk distribution space, which is dominating market activity. Deals over one million square feet are commonplace, and large speculative development is ongoing in a few major markets around the country. However, some large markets are reaching critically low levels of vacancy without available land to accommodate growth of existing businesses. The national vacancy rate, for warehouse and flex space combined, fell another 20 basis points in Q2, settling at 6.8%. In the past four quarters, the vacancy rate has fallen by 60 basis points, but several major market areas, including Los Angeles and Orange Counties in Southern California have vacancy ranging as low as 3%.
New deliveries for both speculative and build-to-suit projects in the US started the year on a strong note. Over 47 million square feet of space in 309 buildings were added to the total base inventory of 21.35 billion square feet. Another 175.75 million square feet was under construction in Q2, 60 up substantially from Q1. The building boom, which is dominated by the construction of larger, bulk distribution facilities, still has a head of steam, but may not be able to keep pace with demand in the hottest markets.
When it comes to construction activity, it’s a case of the haves and have-nots, as building is concentrated in the biggest markets that still have land at prices that make industrial development possible, including Atlanta, Dallas/Fort Worth, Chicago and Southern California’s Inland Empire. In more mature markets like Los Angeles and New York, the danger is in losing base inventory to the repurposing of older properties to mixed-use projects that have residential, office and retail components. Construction of industrial product in those markets remains at a virtual standstill.
Net absorption for the overall industrial market in Q2 hit 75.4 million square feet, well ahead of Q1’s performance, but short of 2014’s fourth quarter tally of 94.7 million square feet. Large distribution users continue to account for the bulk of the net gains. Flex activity contributed less than 10% of the Q2 total. Major leases signed in Q2 included a 1,129,750-square-foot lease to Google in Atlanta and the 1,114,575-square-foot lease for Saddle Creek Logistics in Chicago. E-commerce and 3PL operators continue to make many of the biggest deals around the country. Absorption in almost all primary and secondary markets around the country stayed in positive territory in the second quarter, but tight supply, especially for small to medium-sized owner/users, is running thin. Demand from these companies will only increase as they scramble to secure acquisitions before mortgages get more expensive on the heels of anticipated Fed action. As vacancy has dropped, so have the number of quality choices available to expanding businesses, more of whom are faced with a move to older product with elements of functional obsolescence.
Average asking lease rates for all industrial product rose another 1.3% to $5.62 per square-foot in Q2. Rents for newer distribution product are moving up even faster due to the higher clear height, energy savings and fire suppression technology offered in new projects. But, the rising tide is lifting all boats, as rents are moving up for industrial product across the board.
Investors, anxious to jump on the rent growth bandwagon, are not faring much better than users in terms of locating quality assets for acquisition. Cap rates keep moving down and until the cost of capital begins to head north, the imbalance of supply and demand will worsen. Institutional buyers have shifted their attention to smaller market areas where they can get deals done and achieve slightly higher yields in the process.
The US industrial market should maintain current momentum into 2016. GDP and job growth should be just strong enough to keep markets moving forward at current levels. Interest from foreign investors and domestic institutions to invest in US industrial properties will keep demand running way out front of supply.
Low oil prices should be with us for a while, which is beginning to translate into more consumer spending and more jobs. Lower costs for fuel should also boost profitability and stimulate additional job and wage growth. Energy dependent states will face more layoffs and struggle to maintain local economic growth until energy prices move substantially higher. Expect a further slowdown in domestic oil production until the price of oil rebounds. Fortunately, gains in employment, even in the energy states, are broad-based enough to stay in positive territory overall.
Vacancy rates and net absorption will remain on their current trajectories, except in areas with low supply and limited construction activity. Tenants in those markets may be forced to leave their current markets in order to grow.
Click the following link to download The Lee Industrial Brief Q2 2015
Michael Staskiewicz, CCIM is the Managing Broker/ Senior Vice President of The Garibaldi Group and Founder of EffectiveWorkplace.com. Michael helps innovative, purpose-driven CEOs clarify the strategic plan for a world-class work environment, so they can attract the best talent and reduce voluntary turnover.