Improved Landscape for Industrial Spreads Opportunity
Industrial is hot! There is good news from all around the country, including more evidence of our ongoing recovery. Fundamentals are improving on most all industrial asset types, even in less traditional markets away from the coasts.
The views from industrial real estate experts on the Commercial Real Estate Show from CoStar, King Industrial Realty and Panattoni Development shed some light on several areas of opportunity.
Overall the numbers reveal steady progress in new construction, rising occupancy and modest to above-average absorption rates. Rents are rising faster in major markets, but moving up with room to grow around the country. Declining vacancies and steady upward pressure on rents are creating opportunities for investors.
Although mildly disappointing to analyst Rene Circ of CoStar, the first half of 2014 saw U.S. vacancy rates of 7.2%, even lower than the last big cycle. “We are seeing 20 million square feet of absorption per quarter,” Circ said, “Four to five million better than this time last year.”
That looks like pretty good news. Q2 showed slightly less absorption than Q1, but the year is expected to play out with continued modest growth, ending up the year with a stronger Q4.
It’s a similar story with new construction. The peak of last cycle saw 180 million square feet of supply coming online annually. This year to date we’ve seen 85 million square feet of new construction, both spec and build to suit. That’s half of historic highs, but more than twice what it was a few years ago.
The tight supply is what’s keeping vacancies low and rents up. Circ predicts it will be into next year before we see supply begin to surpass demand.
Manufacturing and light industrial are definitely resurging across the country, and with some new and fascinating patterns. The biggest driver is undoubtedly e-commerce, which is pushing demand for big-box industrial so hard that cap rates are trading among institutional investors at 4 to 5. You could almost argue that the high-end big-box industrial never even saw a recession, Circ noted. E-retailers like Amazon are leasing up millions of square feet.
But that’s not the end of the story. E-commerce needs to get product closer to its customers, and that means business growth moving strongly into secondary and smaller markets. No longer does container shipping dominate the distribution chain as it once did. Now retailers save on shipping by locating fulfillment nearer to consumers. And many of those markets, in turn, are seeing strong improvement in local business, which helps lease up smaller properties.
“This gives me great comfort,” says Circ, “because the local business success points to a much stronger economy overall. It’s better evidence of recovery than just a headline about the GDP.”
Institutional investors have been moving aggressively into the major markets and larger properties, enhancing their allocation of industrial, squeezing cap rates lower.
“Demand for A assets is fierce,” says Sim Doughtie, President of King Industrial Realty. “The trends is pushing all other investors into B & C. What you see them buying now are value-add older buildings, in the secondary and tertiary markets, normally an 8% cap, range, now going for 7.2 to 7.4%.”
Class B and smaller market industrial values are rising, benefiting from both the housing recovery as well as the resurgence in manufacturing. They make an excellent investment right now offering attractive cap rates with the added advantage of expected improvement in rates and occupancy.
Developer Dayne Pryor of Panattoni says debt is definitely coming back. “Of course lenders want plenty of equity involved in the capital stack, but leverage is getting back to what we saw a few years ago, from 55%, now we see it in the 65-70% LTV for a non-recourse construction loan. Well-leased properties are very attractive to lenders.”
If you’re in the market for industrial space, now is the time to get your ducks in a row. It’s a great time to be doing business, with states providing major incentives to lure businesses. U.S. energy, labor and transportation costs are some of the factors attracting on-shoring, bringing manufacturing back to the mainland.
If you’re leasing, and especially if you’re building to suit, you need a great plan and the right team, Pryor says. A great broker, developer, logistics and incentive planner and an experienced real estate attorney are essential.
A key component to site selection is always cost. Pryor notes that building costs won’t vary all that much, contractor to contractor. But site work is a key expense, and poor planning can result in costly mistakes.
Timing is critical. Start your planning a year out at a minimum. Look at your transportation costs to choose your ideal location. Then get a broker and an incentives consultant to help you find the best location. You’re not comparing apples to apples, so it’s going to take more than a good spreadsheet to sort out the options and make the best choice.
Investors may want to focus on secondary and middle markets, B class and smaller properties to take advantage of the strong demand for space and growth in rents. Institutional investors still like A class projects, major markets and new construction, but these cap rates have seen considerable compression. This may a good time to consider selling institutional quality assets while interest rates are low and buyer demand is high.
Users should think about the future and secure space now, as rents are only rising.
Michael Bull, CCIM, is the host of the nationally syndicatedCommercial Real Estate Showand founder ofBull Realty, Inc., a U.S. commercial real estate sales, leasing and advisory firm headquartered in Atlanta. Michael onTwitterandLinkedIn.
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