Industrial Sector: The Next Darling of Commercial Real Estate?

Date: 02/12/2014

In 2013, the industrial market experienced one of its best years since the recession, with an uptick in sales and rents, and a decrease in vacancy rates. Strong momentum and continually improving fundamentals indicate that the industrial sector is on track to have another good year in 2014.

Those were a few of the points made during a recent episode of the “Commercial Real Estate Show,” on which my guests and I discussed industrial real estate leasing and sales performance, including a look behind the curtain.

Good Fundamentals

“The industrial market in 2013 didn’t feel like the slow recovery we’ve been having,” said Rene Circ, director of research at PPR, aCoStar company. The fourth quarter posted 45 million square feet of absorption across the nation, the sixth strongest quarter on record, Circ said. For the year, the industrial market saw absorption of 124 million square feet, up from 84 million square feet in 2012, he added.

High absorption has created a vacancy rate of 7.6 percent nationwide, lower than any other time in the last cycle, Circ said. “You’d have to look back to the Internet bubble years to find lower vacancies. This is the result of a lack of new deliveries. Only 70 million square feet of new space was delivered in 2013, less than half of what would be normal for the markets we track.”

“Our overall portfolio grew in occupancy by 900 basis points in 2013,” said Scott Sealy, chairman of Sealy & Co. “Today it’s about 90 percent occupied.”

With a lack of new space coming to the market, landlords have been able to push rents. Rents grew by about 4.5 percent last year, Circ said. “We’ve developed an index that looks at how widespread rent growth is across the 2,000 submarkets we track, and this year it was 75 percent,” he added.

Retail users continue to be the main driving force in the industrial market, saidMitch Roschelle, partner and U.S. real estate advisory practice leader at PricewaterhouseCoopers (PwC). “Retailers need to get goods to consumers and with the continued rise in fuel prices, they want warehouses that are closer to their customers.”

Rising Sales Volume

Although fourth quarter sales numbers aren’t yet complete, sales volume is expected to have increased by approximately 22 percent for the year, Circ said. “This compares favorably to the other property types. Multifamily sales volume rose by 14 percent, office increased 17 percent and retail by 7 percent. The industrial market is still about 15 percent below the peak in 2007 on a dollar basis, but in terms of square footage being traded, we are at an all-time high.”

Cap rates for regular industrial space are currently around 6.25 percent, the lowest in history, Roschelle said. “The industrial market has experienced strong demand and rent growth, so investors are willing to pay a lower yield.”

According to Sealy, secondary and less-than-core markets will see cap rate compression of another 50 to 100 basis points in the next year. Until interest rates rise by 50 to 100 basis points, cap rates aren’t expected to increase either, he added.

Institutional lenders are interested in making loans again, Sealy said. “Lenders still don’t want to give a lot of credit for properties with high vacancies, but they will give you advances for leasing success.”

Outlook for 2014

With a strong performance in 2013, this year is expected to be another year of continued recovery. “Fundamentals will remain strong in 2014, especially on the rent side,” Circ said. “For occupancy and vacancy, 2014 will be a transition year, given that the supply pipeline is still low. We are tracking just under 100 million square feet under construction.”

Out of the main real estate segments, industrial and multifamily have a lot in common because they have small supply and high demand, Roschelle said.

With an improving market and vacancies tightening, 2014 and 2015 are expected to be strong years for new construction, Circ said. “In 2014, we’re going to see an uptick in construction and new developers entering the market. Now that cap rates are low, some of the big name buyers are going to look at building in places like Dallas.”

Hear more forecasts, including some ‘behind the curtain’ best practices, by accessing the entire show audio on iTunes or the show website.