Through the first three quarter of 2015, the US industrial property market continues to perform with amazing consistency. Net absorption, vacancy, average asking rental rates and construction activity all kept moving in the same direction. Large bulk distribution deals continue to dominate market activity across the country and both speculative and build-to-suit development continues.
However, that activity is concentrated in markets with greater land availability like Dallas, Chicago, Philadelphia, Phoenix, Atlanta and Southern California’s Inland Empire. Other large markets are running out of land to accommodate inventory growth. In markets like Los Angeles and New York, the danger is in losing base inventory to the repurposing of older properties. As a result, construction of traditional industrial product in those markets is nominal.
The national vacancy rate for warehouse and flex space combined fell another 10 basis points in Q3, 6.7%. Since the end of last year, the vacancy rate has fallen by 40 basis points, but several major market areas, including Los Angeles and Orange Counties 60 in Southern California have vacancy rates below 3%.
As a result of vacancy declines across the country, average asking lease rates for Q3 moved up $.06 to $5.63 per square foot. Rents are up across the country, in both primary and secondary markets, but rents in areas with higher levels of construction are seeing the strongest rent gain. Tenants remain willing to pay a premium for first generation space that offers greater efficiency.
New deliveries for both speculative and build-to-suit projects for Q3 hit 59.3 million square feet in 391 buildings. That followed a nearly 51-million-square foot gain in inventory in Q2. The US now touts an industrial property base of 21.44 billion square feet. Another 186.7 million square feet is still under construction, nearly all of that in the bulk distribution category.
Net absorption for the overall industrial market for Q3 hit 76.1 million square feet, just ahead of the 75.4-million-square-foot total in Q2, evidence of consistent demand throughout the country. Over 308 million square feet of net absorption has been recorded in the past four quarters. Large distribution deals continue to account for the bulk of the net gains, with flex activity contributing just 9% to that total. Recent lease signings include 915,000 square feet to Schnuck’s in St. Louis, an 898,560 lease for Wayfair in Cincinnati and a 745,000 square foot deal for LG Electronics in the Inland Empire. E-commerce and 3PL operators continue to make many of the biggest deals around the country.
Supply, especially for smaller buildings, continued to tighten in Q3. Demand from owner/users is still running hot due to the availability of SBA financing at low fixed rates. An interest rate rise, which had been highly anticipated all year, never materialized, so owner/users continue to pursue the opportunity to control long-term occupancy cost with fixed rate loans before the Fed finally pulls the trigger on rates.
Investors, both institutional and private, are still on the hunt to acquire industrial assets. Recently, secondary markets have seen a spike in interest from buyers looking for better yields than they can achieve in major metro areas. Cap rates have compressed to record low levels and that is likely to remain the case due to prospects for continuing rent growth in the industrial sector.
The US industrial market should continue on its present path into 2016. However, if GDP and job growth numbers don’t pick up the pace soon, some wind out of the expansionary sails could be lost. Corporate earnings are coming under more scrutiny, especially in the manufacturing sector, as some of the bigger players are seeing sale declines due to currency fluctuations and slow overseas economic growth. However, the US economy is outperforming the rest of the world and that bodes well for business sectors that are domestically oriented. Interest from foreign investors should remain strong as they see the US as a safe haven for assets that are at increasing risk in non-dollar-based economies.
Vacancy will continue to decline and more markets will begin to see spot shortages of space, especially those areas that have low levels of construction like Los Angeles where vacancy could go as low as 1% in 2016. Low vacancy will be accompanied by a decline in product quality, as well. That will pose more of a challenge to tenants that must remain in their immediate area to keep existing customers.
Net absorption should remain well into positive territory in both primary and secondary markets, but will moderate in areas running short on supply. This will force some users to renew in place and forego planned expansion or risk leaving their current markets in order to grow.
Average asking rental rates will continue to rise, especially in those markets with high levels of new construction. Tenants will pay a premium for quality, as the alternative may be to settle for obsolete space and still pay more.
Construction will remain concentrated in large markets that still have land available at a price point that makes sense for industrial development. Even in those markets, construction costs are rising and entitlement is getting more expensive and time-consuming. This will reduce the chances of overbuilding but may also keep developers from being able to build enough product fast enough to capture current demand.
Click the following link to download Q3 2015 Industrial Brief
Michael Staskiewicz, CCIM is the Managing Principal of Effective Realty Advisors 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.