The U.S. industrial property category has left the economic downturn in the rearview mirror.
Industrial property markets remained tight during the first quarter, as growing demand for big box distribution centers to fulfill e-commerce orders significantly outstripped the new supply of space which, despite a pickup, remains at historic lows, according to recent reports by CB Richard Ellis (CBRE) and Jones Lang LaSalle (JLL), two of the country's leading real estate services firms.
Demand in the industrial market shrugged off bad first-quarter weather and a softening of U.S. export demand and appears poised to party like it's 2006-07, before the financial crisis and subsequent recession sent rents plummeting and brought construction to a standstill. JLL said that about 185 million square feet could be absorbed on a net basis in 2014, meaning there will be far more industrial space occupied than vacated. CBRE forecasts net absorption to reach 164 million square feet for the year. Arthur F Jones, senior managing economist at Los Angeles-based CBRE, said in an email that the firm expects a "relative[ly] stable year" for industrial demand.
The mismatch of supply and demand continued in the first quarter and is expected to persist through the year, making space dearer to come by, according to both firms. The U.S. "industrial availability rate" declined in the first quarter to 11.1 percent, the 14th consecutive quarterly decline, according to CBRE data. The rate peaked during the recession at 14.5 percent, CBRE said.
JLL forecasts 145 million square feet of new construction to be underway by year's end, said Craig Meyer, president of the Chicago-based firm's industrial brokerage arm. Meyer said that the number, which is a conservative estimate, is still at historic lows when measured against the size of the U.S. industrial supply base.
New construction in the first quarter totaled 24.7 million square feet, according to CBRE data. Although that represented the second-highest quarterly total since the recession ended, it is still only half of the normal quarterly construction activity that existed prior to the recession.
The muted construction growth is a vestige of the Great Recession when builders and developers went into hibernation, Meyer said. "For a three- to four-year period, we turned the spigot off. We didn't build a thing," he said. From 2010 to 2012, the number of completed projects hit a 60-year low, according to CBRE.
According to the CBRE report, five markets—Columbus, Ohio; California's Inland Empire east of Los Angeles; Phoenix; Houston; and Dallas/Fort Worth—accounted for 55 percent of the first-quarter 2014 construction activity. Four of those markets are in the Sun Belt, Southwest, and West Coast, markets that were mostly spared winter's fury and where construction could continue. Columbus, located at or near the heart of the nation's transport network, is fertile territory for big-box facilities catering to the nation's seemingly insatiable demand for e-commerce. Not surprisingly, most of the construction demand is in the 350,000- to 500,000-square-foot and higher range, where e-commerce fulfillment tends to live.
The results of the supply-demand imbalance are shrinking vacancy rates and higher rents. The vacancy rate for big-box e-commerce sites, traditional warehousing and distribution centers, and manufacturing plants is expected to drop to 7.5 percent by mid-year, according to Meyer. That would be a new low for the current cycle, which began in early 2008. If current trends continue, vacancy rates could fall to 7 percent or lower by year's end, he said.
In the red-hot Dallas/Fort Worth market, vacancy rates are approaching 5 percent, Meyer said. CBRE noted that Atlanta, which has lagged the national market in recent years, is gaining momentum thanks to increasing trade and inventory flows due to its close proximity to the fast-growing Port of Savannah. Atlanta led the nation with 5.6 million square feet of net absorption in the quarter, doubling its totals for a year ago and putting it on par with 2007 levels, the firm said.
According to JLL data, rents are rising in 48 of the 50 industrial markets it canvasses. Rents in many markets are within 5 percent or less of their peak levels, and rents in some markets have already surpassed earlier peaks, JLL said. Meyer said rents in 2014 will increase, on average, by 3 to 3.5 percent over 2013 levels.
CBRE said rents will continue to strengthen as long as new construction remains relatively subpar. Only when developers start taking on "speculative" projects, where facilities are constructed and a tenant or tenants are then found, will the amount of new supply cause rent growth to level off, CBRE said. That scenario isn't expected to occur until the end of 2016, it said.
At this point, about half of all new construction is "spec," Meyer said. The other half is known as "build-to-suit," where a tenant commits to a site and the facility is custom-designed for its needs. Historically, spec development has accounted for about 80 percent of new activity, Meyer said.