U.S. industrial property market shows signs of life

The ailing U.S. industrial property market showed a pulse in the second quarter for the first time in two years. However, the patient is far from healthy.

That's the takeaway from a report issued Tuesday by real estate and industrial services giant Jones Lang LaSalle (JLL). According to a JLL survey of 38 markets, the average industrial vacancy rate declined to 10.4 percent in the second quarter from 10.6 percent in the first quarter, the first sequential decline in vacancy rates since the financial crisis exploded in September 2008.

JLL's second-quarter North America Industrial Outlook showed that average "net absorption"—the amount of space being leased relative to the space being returned to the market—stood at 11.1 million square feet in the quarter. However, the net absorption figure through the first half of 2010 remains at a minus 7.4 million square feet, meaning leasing activity, while improving, is still not keeping up with the amount of space being vacated, according to the JLL survey.

Markets like New Jersey and California's Inland Empire, where prices have plummeted since the recession began, showed positive net absorption year to date, the survey found. In addition, the Dallas market has reported positive leasing activity, the report said.

Craig Meyer, managing director and head of JLL's logistics and industrial services group, said the category remains vulnerable to any downshifts in the economy. "While we can report some overall positive news for the sector, we are still very much at the mercy of this precarious economy," he said in a statement. "Declining consumer confidence, the fading impact of the federal stimulus support, and worldwide economic volatility are forcing many industrial landlords, tenants, and investors to look back over their shoulders in fear of a double-dip recession."

The nation's industrial markets are not moving in lockstep. For example, it has grown increasingly difficult to locate 350,000-square-foot properties in markets like Indianapolis and the Inland Empire. By contrast, there is an abundance of 100,000- to 200,000-square-foot facilities virtually throughout the country, the report said.

The report showed that two-thirds of the markets tracked by JLL experienced positive net absorption in the quarter, while 20 percent showed declining absorption. Major industrial markets like Chicago and Los Angeles account for a combined 8.3 million square feet of negative net absorption so far this year, the report said. However, both markets are showing recent signs of stabilizing, with submarkets around their ports and airports benefiting from recent growth in container traffic and aircargo tonnage, according to the report.

Meyer said developers have deliberately avoided overbuilding during the downturn, with much of the overall weakness attributed instead to a decline in demand. The cautious approach has continued. Only 11.3 million square feet of new construction is in the pipeline, and 83 percent of that is pre-leased, Meyer said. "There is no speculative building going on," he added.

Although the pace of decline in "asking rents" has slowed, Meyer said many developers and lessors are still aggressively packaging their parcels both in terms of price and perks. Renewals account for a large share of current leasing activity, so the trend toward renewing leases at lower rates or with perks included—known in the industry as "blend and extend"—remains popular, Meyer said.

"Competition for tenants is fierce in almost every market, and... concession packages, including periods of free rent and tenant improvement packages, continue to be a critical component when completing deals," Meyer said. "We will continue to see price degradation across many markets" before supply and demand come into alignment and rents begin to climb, he said.

The survey found the lowest industrial rents in Columbus and Memphis, with the highest in San Diego, San Francisco's Bay Area, and South Florida.

Meyer said he would like to see two or three successive quarters of declining vacancy and positive net absorption rates before he feels confident in a sustainable recovery. "I'm expecting about two more years of this," he said, referring to the current volatility and overall softness.

One encouraging note for developers and lessors is that the supply of sublease space has decreased nationwide, a sign that demand is on the rise again. Northern and Southern California have the highest volumes of marketed sublease space, followed by mid-tier markets like Memphis and Nashville, the report said.

In addition, demand for high-end prime logistics space is topping the general market and has given a boost to Midwest markets like Memphis; Columbus, Ohio; central New Jersey; Philadelphia; and Harrisburg, Pa., the report said.