On the national level, the industrial asset class is white hot right now, experiencing record low vacancy rates and significant sales volume on both a local and national level. Sales volume has also started to pick up due to a severe shortage of new starts (although there is a vast amount of new industrial construction underway which should alleviate some of the pent up demand in 2016). If you own or wish to lease industrial property here in either Whatcom or Skagit County, there are both opportunities and issues to be aware of. This article is based on an August 2015 talk given by René Circ, Director of Research – Industrial, and Manager of Industrial Portfolio Strategies at Costar, the commercial real estate industry’s leading provider of information and analytics.
2015 YTD Property Level Performance
On the national level, the industrial asset class is doing exceptionally well, quarter over quarter, leading all other property types in all metrics including total demand, occupancy improvement, rent growth and now even sales growth. In fact, the only metric where this segment lacks is on the supply side like multi-family. It is a star category right now.
Rent growth in the industrial sector has been extremely strong. The first quarter increased by 6% for smaller industrial buildings vs. last year (with larger buildings running about 5.1% rent growth). Compare this to the normal growth rate of 1% in most markets, meaning crazy good times for the industrial real estate segment.
An improving economy but with a slow recovery has kept new industrial inventory from being added as quickly as it would have under normal circumstances, resulting in record-low vacancy rates. Vacancy rates for logistics buildings was currently around 8% on the national level in Q1-Q2 of this year. Light industrial is leading the demand with sub 5% vacancy rates which Circ predicts we probably won’t see again.
The smaller buildings suffered disproportionately during the recession with local markets being more heavily impacted by the recession, but now we are starting to see demand increase in the smaller buildings with increased rental growth happening there. Cumulative demand in the light industrial segment is now driving all industrial segments which is a strong indicator of the health of the US economy.
Flex space on the other hand is not doing as well. This is the most volatile segment of the market and it is under performing.
Regarding the investment market, the industrial asset class has been very hot for sellers due to cap rate compression, just as with multi-family, which Circ predicts will continue.
Sales volume in industrial has been off the charts. The first half of 2015 saw industrial sales up by 40% vs. last year and we are currently running at about $40 billion with only half the year over, vs a normal annual volume at about $60 billion for the entire year.
The biggest change that has occurred to cause this volume increase has been the big portfolio investors coming into this segment and buying up properties.
Non institutional markets (light industrial) are also up, but not as much as the institutional markets because these are generally smaller buildings with less activity from the big portfolio investors, but the interest is there according to Circ, who is advising Costar clients to move quickly into this segment.
There is also a lack of available for-sale modern, high quality industrial properties with services like 3 phase power. This lack of supply will continue to drive cap rate compression which analysts predict will remain at all-time lows. Possible rising interest rates won’t likely raise cap rates unless they go up very fast by more than 150 basis points. There is room to absorb 100 basis points in the spread in Circ’s opinion.
The primary activity is now happening in the gateway office markets which include cities like San Francisco, New York, Los Angeles, and Boston. That’s where most of the foreign investment is going. At Costar their saying is: “foreign capital does not take industrial flights. To get to industrial you have to change planes a few times”.
The Industrial Market in Different Cities
Overall in the industrial class, here are some sample cap rates to consider: SF Bay Area is at a 4 handle. Moving more inland, you can start to achieve cap rates in the fives. Dallas is now pricing comparably to California. We are starting to see some cap rates in some markets like that potentially go up, but a 5 cap would be the expectation. In the light industrial segment on the national level, cap rates are in the sevens, and Circ feels that further cap rate compression is possible. Foreign buyers of the industrial asset class have traditionally come from places like Germany, Norway, the Middle East and more recently Asia but to a much lesser extent.
The Industrial Market from a Builder’s Perspective
Larry Calahan, CEO of Patillo Industrial real estate, gave this feedback on the industrial market:
“Almost nothing got built in most markets during the recession. There were a lot of empty spaces and the space was being underutilized. Now suddenly almost everything is full and national vacancy rates are approaching record lows. People were building mostly mega buildings (800k SF+) but the core of the market is much closer to the average size of from 45k – 200k SF. As a result, inventory is sorely lacking.
What do strong industrial tenants look for according to Calahan? Generally, markets growing at 2% a year and those with strong ports, including inland ports (major railway hubs) for goods distribution.
Calahan feels that online retail is driving a lot of performance in the industrial market and the next day, or very fast shipping turnaround times that consumers now expect. Where once a large distribution facility located somewhere along a major freeway was sufficient for goods delivery, now faster shipping times necessitate being closer in to the population receiving the goods which is driving growth in smaller light Industrial spaces close in to population centers. He sees that trend continue, especially given the much lower rent rates for light industrial vs. retail. In other words, light industrial is the new retail.