Scotsman Guide > Commercial > August 2014 > Department

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Commercial Department: Property TypeCast: August 2014

 

Property TypeCast

Slow improvement signals uneven industrial recovery

Improvements in industrial real estate fundamentals reflect the restrained pace of recovery in the overall economy. The industrial market continued along its slow recovery path in this past first quarter with the national vacancy rate for the warehouse/distribution subsector falling by just 10 basis points. A combination of increasing net absorption and a decline in construction activity was not enough to boost occupancy at a quicker rate. This occurred in a quarter where the economy appeared to soften, a disappointment after hopes of acceleration in growth were heightened by promising economic data in late 2013. Although this softening was partially a result of seasonal factors, it was also a reminder of the uneven nature of this recovery.

Warehouse/Distribution Net Absorption and Vacancy; Industrial Effective-Rent Growth. Source: Reis Inc.

Warehouse/distribution improvements

Supply-and-demand dynamics in the warehouse/distribution market were in line with the market environment in 2013. The warehouse/distribution vacancy rate fell 10 basis points for the fourth consecutive quarter to 11.5 percent.

The national vacancy rate has now fallen 270 basis points from its cyclical peak of 14.2 percent. Net absorption increased slightly from the previous quarter, but was comparable to the quarterly average demand for space from 2013. Total net absorption for this past first quarter was 15.4 million square feet, roughly in line with the 15.5 million square feet average from the previous four quarters.

More than 9.4 million square feet of warehouse/distribution space were completed in this past first quarter, a 17.2 percent decline from the previous quarter. Adverse winter weather across the country likely contributed to the dip in construction activity, with project completion dates being pushed back. Construction activity was on par with the average quarterly rate of new-supply additions from 2013. Tightness in the Class-A market is serving as a catalyst for new construction. Reis expects new supply of nearly 66 million square feet for the year, up from the 36.5 million square feet completed in 2013.

Asking and effective rents grew 0.4 percent and 0.7 percent, respectively, in this past first quarter compared with increases of 0.4 percent and 0.5 percent in the previous three months. The higher effective-rent growth, although modest, implies a further tightening of concession packages for tenants. Moreover, year-over-year rent growth is now at its highest point since the end of the recession. Asking and effective rents were up 1.7 percent and 2.1 percent, respectively, over the past 12 months.

Flex/R&D

The national flex/research and development (R&D) vacancy rate declined 20 basis points to 13.4 percent in this past first quarter. Vacancy is down 50 basis points over the past year and down 250 basis points from its cyclical high. Similar to the warehouse/distribution subsector, the flex/R&D market benefitted from a combination of increasing demand and declining completions. Net absorption totaled 2.4 million square feet, up 50.8 percent from the previous quarter and the highest quarterly figure since 2012. Meanwhile, new construction was at its lowest level in two years, with only 150,000 square feet of space opening its doors in this past first quarter.

Rent growth, while modest, achieved its highest quarterly level since early 2012. Asking and effective rents increased 0.3 percent and 0.5 percent in this past first quarter, up from 0.2 percent and 0.3 percent in fourth-quarter 2013. Accelerating rent growth is closely mirroring the slow increases in demand.

Near-term outlook

The economy got off to a poor start this year, with gross domestic product (GDP) growing at a mere 1 percent in this past first quarter, with further downward revisions possible. Despite the lackluster performance, expectations are for GDP growth north of 3 percent in this past second quarter. Although Europe’s economy remains fragile and emerging markets have softened, the United States is among the bright spots around the world. Improving U.S. economic growth will continue to fuel the recovery in the industrial sector.

Reis projects warehouse/distribution vacancy to decline another 30 basis points to 40 basis points by the end of this year, similar to the pace of decline in 2013. Rent growth, however, will accelerate, reaching around 2.8 percent for effective rents in 2014, compared to the 1.6 percent increase seen in 2013. Demand for high-quality warehouse/distribution centers will drive rents higher, bolstered by the growing need for space by companies in the e-commerce, logistics, auto and housing industries. The flex/R&D subtype is expected to see a similar 40-basis-point decline in vacancy in the last three quarters of this year. Rent growth will lag behind its industrial counterpart, but expectations for around 2 percent effective-rent growth will more than double the 0.8 percent increase observed in 2013.

Brad Doremus, senior analyst for Reis’ economics department, contributed to this article.


 

Victor Calanog is chief economist and senior vice president for research at Reis Inc. (www.reis.com). He writes a monthly column on property types for Scotsman Guide. Calanog and his team of economists are responsible for data models, forecasting, valuation and portfolio services for clients in commercial real estate. Reach him at victor.calanog@reis.com.

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